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Rating agencies face sanctions by EU watchdog

Ulrich Baumgarten | Getty Images

The latest dent in credit rating agencies' (CRAs) reputation could be legal action from the European Union, following a scathing report into how they set their all-important scores.

An influential EU agency, the European Securities and Markets Authority (Esma) which was set up in 2011 to examine the rating agencies, has published a report which criticizes the three main ratings agencies: Moody's; Fitch and Standard & Poor's (S&P). The agencies are accused of "reliance on junior support staff" and "disclosure of upcoming rating actions" to unauthorized third parties, among other alleged failings. Esma has also warned it "may take action as appropriate in due course" if it finds that any of its findings amount to a breach of regulations.

"Esma's investigation revealed shortcomings in the sovereign ratings process which could pose risks to the quality, independence and integrity of the ratings and of the rating process," Steven Maijoor, Esma chair, said.

"The CRAs who were subject to this investigation still need to make improvements in their working practices to ensure their full compliance with the CRA Regulation and to eradicate inadequate practices from the past."

(Read more: Can you still trust rating agencies?)

The years since the credit crisis have seen increased focus on the role of rating agencies. S&P famously downgraded Greece while the debt-ridden European country's bailout by international lenders was being renegotiated, leading to protests from Greek politicians. Esma was set up in the light of concerns that the rating agencies accelerated the pace of the euro zone debt crisis.

Rating agencies have also been criticised for not responding quickly enough to change, and for failing to spot the sub-prime mortgage crisis. The U.S. government has sued S&P for $5 billion over its positive assessment of controversial mortgage-backed securities, which eventually brought down Wall Street banks Bear Stearns and Lehman Brothers. However, S&P has suggested that the $5 billion action was really in response to its downgrade of U.S. government debt in 2011.

(Read more: How to fix rating agencies)

The big three CRAs dominate the market, with a share of 95 percent between them. Yet their actions' power to move markets seems to be in decline. When S&P downgraded the Netherlands last week, its main stock index the AEX, and the yields on its 10-year bonds, which measure the cost of it borrowing money, barely flickered.

The big three agencies have also seen some challenges posed by relatively new Chinese rating agency Dagong, which takes a comparatively skeptical line on U.S. and European sovereigns, and gives the U.S. a lower credit rating than China.

(Read more: Are rating agencies selling out?)

A spokesman for S&P said: "We are committed to the highest standards in our ratings activities and are continually enhancing our analytics and operations with that in mind."

A spokeswoman for Fitch said: "While we are confident that all our policies and procedures meet regulatory standards, we are moving swiftly to address any issues identified in the report."

Meanwhile, a spokeswoman for Moody's added that the company "was committed to complying with the European regulations and effectively managing any potential conflicts of interest as we continue to enhance the performance, processes and transparency that underpin our ratings."

Clarification: This story has been updated to include a comment from Moody's.

- By CNBC's Catherine Boyle. Twitter: @cboylecnbc.

Contact Europe: Economy

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