EU Curbs Unsolicited Ratings of Sovereign Debt

They've gone and done it – in what appears to be a clear violation of the right to free speech, credit rating agencies will henceforth no longer be allowed to rate the debt of bankrupt EU sovereigns as they please – instead they will only be allowed to change such ratings three times a year and otherwise will first  have to go begging to regulators if they want to issue a ratings change outside of these fixed points in time.

We do believe that the business model of the rating agencies is seriously flawed (Egan-Jones excepted, for obvious reasons), as issuers of debt are paying for the ratings, which represents a clear conflict of interest. The mortgage debt crisis has starkly revealed these flaws. No such conflict of interest exists however when it comes to their ratings of sovereign issuers, as those are unsolicited and paid for by no-one.

In other words, the EU is trying to shoot the messenger, leaving investors in the lurch in the process. It would do better to simply get its unruly members to stop their overspending and get their finances in order.

The Bloomberg article on this overbearing bureaucratic activity is not without ironies:

On sovereign debt ratings, lawmakers and officials agreed that each credit rating firm must pick three days a year when they would be allowed to give so-called unsolicited assessments of governments’ creditworthiness, according to Jean-Paul Gauzes, a lawmaker involved in the talks. Ratings firms may get a chance to issue unsolicited ratings — those that haven’t been requested and paid for by a client — outside those dates if they can justify it to regulators.

“Credit rating agencies will have to be more transparent when rating sovereign states, respect timing rules on sovereign ratings and justify the timing of publication of unsolicited ratings,” Barnier said. “They will have to follow stricter rules which will make them more accountable for mistakes.”

Lawmakers had to overcome “perverse” resistance from national governments to the curbs, Gauzes said.”


(emphasis added)

When Gauzes talks about a 'perverse resistance' by national governments to this vile abridgment of free speech, it shows that he doesn't know a thing about markets. The ratings actually help most governments to market their debt – in normal times, they are a seal of quality that attracts investors. Even those who have seen their ratings decline of course want to see them getting raised again at the earliest opportunity – and not just 'three times a year'. Besides, the rating agencies are anyway usually light years behind the market's own assessment, so it is not quite clear what the EU even hopes to achieve with this.

The bonds of overstretched debtors will still get mauled anyway. In fact, by reducing the frequency of ratings actions, they will only induce all the more market speculation about what those actions will be when they are finally published, which is likely to increase, not decrease market volatility. One can always rest assured that such interventions will have a plethora of unintended consequences. One of them will very likely be that investors will increasingly flock to the bonds of countries where no such curbs on the ratings process exist and shun the bonds of those countries where they are now in force.

After the useless ban on CDS trading, another 'Michel Barnier special'. Can someone please ship this guy off to North Korea? He'd fit right in there.




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One Response to “Shooting the Messenger”

  • Floyd:

    Many thanks for your posts, Pater.

    A *benefit* of this policy is that it would delay the junk rating for some of the sovereign debt, which would delay those watershed events where major funds have to dispose of just-been-junked bonds.
    This in return will delay the resulted collapse in the price of such bonds as supply is withheld from the market.

    It actually might work for a while, till the market loses faith at once.
    Albeit, as large portion of the market is institutional investors* it actually might work for quite some time.
    (*) This text assumes institutional investors care more about their relationship with the sovereign than the best interest of their customers.

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