Canadian securities regulators are finally introducing their first major policy response to the 2007-08 credit crisis, a new regulatory regime for credit-rating agencies.
In late January, the Canadian Securities Administrators announced that it is adopting a new rule that will impose requirements on rating agencies. The rule establishes a regulatory framework for the oversight of rating agencies by requiring them to apply to become a “designated rating organization,” which means they must adhere to requirements concerning conflicts of interest, governance, conduct, compliance and regulatory reporting.
Until now, the rating agencies have not been subject to any formal regulatory oversight. And, in the aftermath of the financial crisis, which began in Canada in August 2007 with the freezing of the market for non-bank-sponsored asset-backed commercial paper, a number of regulatory weaknesses were identified as contributing factors. Among those, the lack of regulatory oversight of the rating agencies was singled out as a particular problem.
Since then, regulators around the world have been developing ways to improve oversight of the rating agencies and lessen the potential for conflicts that may compromise those agencies’ opinions, as well as reduce investors’ reliance on such ratings. One of the reasons why the rating agencies played such a key role in the crisis is that securities legislation requires the use of ratings in various ways, which may have contributed to investors placing undue trust in those ratings.
When the CSA first sat down to analyze the crisis, one of the first recommendations it came up with, published in a paper in October 2008, was the proposal to introduce a new regulatory regime for rating agencies.
Initially, that proposal imagined only that the rating agencies would be required to comply with a code of conduct developed by the International Organization of Securities Commissions — which addresses issues such as conflicts of interest, ratings transparency and methodology — or the raters would have to explain why they deviated from that code, known as a “comply or explain” approach.
While this sort of flexible model had appealed to the rating agencies, it also became clear that it probably would not be acceptable to European regulators. Under the new European regime for rating agencies, the European Commission must deem that the regulatory standards of other countries are equivalent to EU standards before ratings from those countries can be used in Europe. If the Canadian rules didn’t measure up, then Canadian ratings would not be used in Europe. That could hurt both Canadian rating agencies and issuers that use these ratings in Europe.
So, in order to meet European standards, the CSA had revised its proposed rule in March 2011, effectively abandoning the “comply or explain” approach. Instead, the rating agencies are required to establish, maintain and comply with a code of conduct that incorporates a list of requirements set out in the CSA’s rule. Those requirements are based largely on the IOSCO code but have been revised to clarify the conduct that Canadian regulators expect.
Only a handful of comments were received on that version of the CSA proposal, and while the regulators did make a couple of changes in response, those are not meaningful enough to require a further comment period, so the rule now has been finalized. The new regime is slated to take effect on April 20, pending the legislative changes and ministerial approvals that are required to implement it.
Restrictions on the use of foreign ratings in Europe are due to come into force on April 30, so the hope is that the European authorities will give the Canadian regime its blessing before then.
Back in December, the Euro-pean Securities Markets Au-thority had announced that it is at an advanced stage of reviewing the regulatory regimes of several countries, including Canada, and that it expects to endorse them. But ESMA has not yet done so officially.
In the meantime, while the CSA’s rule has been beefed up to meet international standards, Canadian regulators are not following the lead of some other countries by also imposing greater civil liability upon rating agencies. Says the CSA in announcing the new rule: “We are not at this time proposing such changes because we do not think that the benefits of subjecting designated rating organizations to ‘expert’ liability in Canada would outweigh the potential costs.”
Nevertheless, with this new regime for rating agencies, Canadian regulators have completed a key reform in response to the financial crisis. Another major effort — the review of the exempt market regime — is ongoing, but changes in that area appear to be far off. IE