Despite the best efforts of US and European
regulators, financial regulation experts say the market is no
closer to finding an alternative to credit rating agencies.
In an IFLR web
seminar on September 14, Simon Gleeson of Clifford Chance
in London and Donald Lamson of Shearman & Sterling agreed
that while there is a strong will to reduce the financial
market’s dependency on ratings, a viable, concrete
proposal has yet to arise.
“The policymakers are between a rock and a
hard place on this, while they would like there to be a third
option there doesn’t appear to be one,” said
Gleeson.
Europe has been following the discussion in the US
with some interest, said Gleeson, as the way ratings are
embedded in statute means a lot of effort has gone into coming
up with other options. But despite this, the US hasn’t yet
come up with any viable options.
Donald Lamson agreed. “The lack of
alternatives is one of the reasons why the rulewriting on how
to eliminate where possible references to the rating agencies
in regulations has come to a grinding halt,” said
Lamson.
“There are some instances where it happens and
the agencies trumpet their success in this, but not a lot in
the aggregate.”
Two unacceptable
options
While no alternative yet exists, regulators still
insist that another way must be found.
In a press conference launching the Capital
Requirements Directive 4 (CRD 4) in Brussels on July 20, EC
Internal Markets commissioner Michel Barnier stated that the
financial system is too dependent on ratings, and that
financial institutions should have more of a say.
“We are proposing to strengthen the
requirements for banks to carry out their own risk analysis
without resting in a mechanical fashion on the ratings
agencies,” said Barnier.
According to Gleeson, the debate is similar to the
accounting debate after Enron, in that there are only two ways
you can arrive at a balance sheet figure. One of them is by
reference to an external reference and the other is by letting
management take their own judgement.
“Enron reminded the accounting profession that
saying to management ‘well you make your own
judgement’ isn’t always the most efficient way of
doing anything,” he said.
On the other hand, if you pick an external
reference, that reference might be wrong.
“We’re oscillating between what they
regard as two unacceptable alternatives, but unless someone
does come up with a viable third option they’re just going
to have to pay their money and make their choice,” he
said.
Through Dodd-Frank, US regulators tried an approach
where they mandated the ratings agencies to put information on
their websites for banks to come up with their own approaches
to rating risk. But so far no suitable suggestions have
arisen.
According to Lamson, simply providing information
to people doesn’t mean they can use it any better.
"It's optimistic to think that they're going to
come up with a better approach than the rating agencies on
their own," he said.
“Granted, rating agencies were massively wrong
in a number of things they did, but at the same time
they’re relied upon for a very good reason, because quite
often they get it right.”