Europe Economy

Ratings Agencies Come Under Fire From EU Watchdog

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The European Union's markets watchdog has criticized the world's top three credit ratings agencies for a lack of transparency over how they evaluate banks and demanded more robust internal reviews of their methods.

The European Securities and Markets Authority (ESMA), which studied Moody's, Fitch and Standard & Poor's, said on Monday there was inadequate disclosure of the in-house methodologies used to compile their ratings and how they keep these methods under review.

One criticism was that the agencies, after making changes to their rating methods, did not then place the actual ratings on the banks under observation for possible change as well.

The agencies must now review within six months any individual ratings affected by methodology changes.

Announcing the results of its second annual review of the banking sector, ESMA said it looked at bank ratings because of their close link to ratings of government debt, a focus of the euro zone crisis.

The EU has passed three sets of laws over the past three years to directly supervise ratings agencies after finding flaws in ratings during the 2007-09 financial crisis. Some securitized products became untradeable despite being given high ratings.

Rating downgrades of sovereign debt of some euro zone countries during the crisis also angered policymakers. For example, Standard & Poor's infuriated Greece in 2011 when it cut the rating on its sovereign debt while the country's EU bailout was being renegotiated.

ESMA, which supervises 20 agencies, said on Monday its annual review found that ratings agencies in general have not "sufficiently embedded" the main requirements of EU rules.

"Considering the continued importance of credit ratings in financial markets, it is extremely important that credit rating agencies identify and remedy these issues in their businesses which may undermine the independence, objectivity and the quality of credit ratings," ESMA Chairman Steven Maijoor said.

The Paris-based watchdog has put in place "remedial action plans" for the three agencies, which make up the bulk of ratings globally.

They will have to detail all relevant factors, models, assumptions and criteria used in calculating a bank's ratings. They must also keep better records and improve internal reviews of how their methodologies are performing.

Moody's spokesman Daniel Piels said: "Moody's is fully committed to complying with the European regulation and to further enhancing the transparency, performance and processes surrounding our ratings as part of ESMA's continuing supervision of our industry."

S&P said it was enhancing its rating processes and activities and committed to making further improvements.

Fitch was unable to comment immediately.