Credit rating agency failures continue despite EU reforms, paper finds

European Union regulations have reduced some failures in credit ratings’ agencies’ assessment of securities, but not all, a research paper finds.

In The impact of regulatory changes on rating behaviour, published by the European Central Bank (ECB), Nodirbek Karimov, Alper Kara, Gareth Downing and David Marques-Ibanez examine conflicts of interest between ratings agencies and issuers of securities.

The authors look at a sample of 12,469 tranches of asset-backed securities, or ABS, issued between 1998 and 2018. European Union authorities imposed a series of regulations on credit ratings agencies from 2009 to 2013, due to their role in the global financial crisis.

The authors examine the differences between those securities issued before and after the regulatory changes. The researchers particularly look for evidence of “rating catering” and “rating shopping”.

They define “catering” as when a ratings agency accommodates a securities issuer’s demands. “Shopping” is where an issuer declines to accept a ratings agency’s assessment of its security, and finds another prepared to give it a higher score.

“Rating catering seems to have disappeared” after the global financial crisis, because of the introduction of the new regulations, the authors find. But they find the new regulatory regime has been much less effective in reducing rating shopping.

One possible reason could be that most issuers can still decide whether to accept an agency’s rating, or look for another firm, the paper says. The new regulations also specify that at least two agencies must rate a security. But this still allows issuers to “shop” for another agency if one of the first two ratings is lower than it wanted.

Some securities markets participants may still be over-reliant on ratings agencies for information, especially investors in triple-A asset-backed securities, the paper finds.