EU Moves to Regulate the Rating Agencies; SEC Should Follow Suit

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 |  Includes: MCO, SPGI
by: Tom Brown

It’s about time. European regulators have at last proposed rules to prevent the rating agencies (perhaps the biggest villains of this whole credit crackup, in my view) from ever again helping drive the global financial system into the abyss. Not a moment too soon! The rules aren’t perfect, but they’re a good start.   

Under the plan, ratings agencies will fall under the direct supervision of EU regulators, and won’t be allowed to provide consulting services to issuers who also pay them to provide ratings. Agencies would also have to appoint outside experts, who wouldn’t be paid based on the company profitability, and couldn’t be fired.

Best of all, the agencies would no longer be allowed to claim their ratings are mere “opinions,” so that they might be held liable for their own misconduct or incompetence. 

Good—as far as it goes. But I’d go farther. For one thing, I’d ban the inclusion of “ratings triggers” in credit agreements, and would declare existing triggers unenforceable. That way, ratings downgrades (which, as we’ve seen lately, can be highly arbitrary and capricious) wouldn’t have the potential to send a company into a sudden financial tailspin for no reason.

But there’s an even simpler way to fix the rating-agency problem, I believe: get rid of credit ratings altogether. Let fixed-income investors do their own research, just the way equity investors do. If fixed-income types hadn’t relied on the ratings crutch in the first place, this whole credit crackup wouldn’t have gotten so out of hand.   

Anyway, good for the EU. The SEC needs to do something similar.