Regulated credit rating agencies (CRAs) wield significant power in capital markets. Their ratings have a huge impact on the fate of issuers, investors and other market participants. Credit rating agencies were heavily criticized for their role in the 2008 financial crisis. Consequently, the regulatory focus of travel to date has been to strengthen regulation of credit rating agencies and attempt to reduce the dependence on their ratings. However, the scope and importance of ratings from rating agencies continues to grow, especially in the ESG space. On December 31, 2020, the FCA entrusted ESMA with responsibility for the oversight and enforcement of credit rating agencies. CRAs are an area of particular interest for FCA. This article will examine: (1) FCA concerns and expectations and (2) the direction of regulatory travel.
FCA concerns and expectations
On February 23, 2022, the FCA published its first portfolio letter to regulated rating agencies. In this letter, CAF set out its concerns and expectations. Additionally, CAF said that “we will enforce… where appropriate, with real and meaningful consequences for companies that fail to follow the rules”. The FCA has also set out the monitoring measures it will take, including, among others, “places of control”.
FCA concerns and expectations include:
- Scoring process and methodologies – The FCA expects rating agencies to: (1) document the rating process and explain the key risk factors considered when assigning ratings; (2) mitigate any conflicts of interest in the review methodology and process and disclose with clear rationale any updates to the methodology or process; and, (3) meet FCA reporting obligations with sufficient detail in a timely manner.
- Governance and Oversight – FCA expects CRAs to expose “good governance through effective board oversight and an internal control structure to ensure an independent ratings process and methodologies free from conflicts of interest”.
- Market and scope risks – Noting that rating agencies are increasingly active outside the regulatory perimeter, the FCA said it “be proactive to the limits of [the] regulatory scope”.
direction of travel
CAFs are and will continue to shine a spotlight on CRAs to ensure that their services are provided in a fair, efficient and transparent manner. Two areas of particular interest are likely to be:
- ESG ratings – One of the reasons rating agencies are becoming increasingly important is their role in providing ESG ratings. Opimas has estimated that the global market for ESG data and ratings could exceed US$1 billion in 2021. ESG ratings from ratings agencies fall outside the regulatory scope of the FCA. A key element of the FCA’s ESG strategy is to ensure “Integrity in the ESG labeled securities market, supported by the growth of effective service providers – including ESG data providers [and] odds…”. The FCA recognizes that as industry players further integrate ESG considerations into their operations, they will increasingly depend on rating agencies. It is therefore “important that these services are provided in a fair, efficient and transparent manner”. Although this is outside the perimeter, the FCA says it will be proactive at the edges of the regulatory perimeter. See previous cover, “Greenwashing and Information Asymmetries: The FCA’s Directions.”
- Senior managers and certification scheme – The FCA is working with HM Treasury on the potential extension of the senior management and certification scheme to CRAs. Under current EU rules, credit rating agencies are subject to a registration process. The purpose of this proposed change would be to provide greater accountability and strong oversight. It would also likely facilitate the process of taking disciplinary action.
Given the crucial role that rating agencies play in facilitating the flow of capital, the FCA is likely to shine a spotlight on rating agencies more and more. The first regulatory warning signals have been reported. As the era of cheap money draws to a close, markets and regulators will be interested in the ARC’s fair, efficient and transparent responses.