The European Union said Tuesday it wants to allow investors to sue credit rating agencies for compensation if they break EU regulations “intentionally or with gross negligence.”
The proposal from the European Commission, the EU’s executive, is part of a new set of rules for credit rating agencies, which have found themselves under attack during the 2008 credit crunch and the ongoing sovereign debt crisis in the eurozone.
The regulation, which needs to be approved by EU governments and the European Parliament, also requires agencies to be more transparent over how they decide on a country’s, or company’s, credit worthiness and to warn bond issuers of a change in rating one day ahead of publishing it.
Since the 2008 credit crunch, regulators around that world have been working to limit the power wielded by the Big Three agencies — Standard & Poor’s, Fitch Ratings and Moody’s Investors Service — which dominate some 95 percent of the global rating market.
Bond ratings are important because they often determine whether certain investors — such as big pension or money market funds — can buy or even own them and a downgrade can trigger a sell-off in a country’s or company’s bonds.
Making rating agencies liable for their decisions could potentially spark expensive lawsuits in civil courts around the 27-country EU, although several states, including France and the United States, already have similar provisions and have not seen high-profile legal cases.
Credit rating agencies have so far defended their assessments as opinions protected by freedom of speech — a claim that the Commission rejected.
“Ratings have a direct impact on the markets and the wider economy and thus on the prosperity of European citizens,” said Internal Market Commissioner Michel Barnier. “They are not just simple opinions.”
Crucially, the new rules would place the burden of proof in a lawsuit on the rating agency rather than the plaintiff.
“Given that it would often be difficult for the investor to prove what the reason for the breach of the regulation was and whether this breach was due to gross negligence … it will be for the (credit rating agency) to prove that it applied the necessary care,” the Commission said.
Whether moving the burden of proof to the rating agency will be enough to allow for successful compensation claims is questionable, however.
“Proving the rating agency to be wrong in specific rating decisions is a very difficult thing to do,” said Nicolas Veron, a senior fellow at Brussels-based economic think tank Bruegel.
Ratings assess the probability of an entity defaulting of its debt and even if the probability is seen as very low, it still exists, Veron said.
The new regulation also seeks to fight conflicts of interest between bond issuers and the credit rating agencies that assess them.
Companies, which have to pay agencies to assess their credit worthiness, would be required to change agencies every three years to avoid too much reliance. At the same time, agencies would not be allowed to rate companies in which they or their parent companies hold a financial interest.
On top of that, the new rules would ban large rating agencies from taking over smaller competitors over the next decade. The Commission hopes that, together with the new rotation requirement, will allow smaller agencies to grow and compete with the Big Three.
However, Barnier failed to convince the rest of the Commission, which includes officials from all other EU countries, to support a temporary ban of credit ratings for countries under an international bailout program.
The French commissioner had pushed hard for such a ban during in a three-hour-long debate with his colleagues. He said that the Commission would try to agree on a ban in the future.