Regulated credit rating agencies (CRAs) wield significant power over capital markets. Their ratings substantially impact the fates of issuers, investors and other market participants. CRAs were significantly criticised for their role in the 2008 financial crisis. Consequently, the regulatory direction of travel to date has been to strengthen the regulation of CRAs and attempt to reduce reliance on their ratings. However, the scope and importance of CRAs' ratings are ever-growing particularly in the ESG space. On 31 December 2020, the FCA took supervisory and enforcement responsibility for CRAs from ESMA. CRAs are a particular area of focus for the FCA. This article will consider: (1) the FCA's concerns and expectations and (2) the direction of regulatory travel.
The FCA's concerns and expectations
On 23 February 2022, the FCA issued its first portfolio letter to regulated CRAs. In this letter, the FCA set out its concerns and expectations. Further, the FCA stated that "we will enforce…where appropriate, with real and meaningful consequences for firms who do not follow the rules". The FCA also set out the supervisory steps it will take including, among others, "spot checks".
The FCA's concerns and expectations include:
- Ratings process and methodologies - The FCA expects CRAs to: (1) document the ratings process and to explain the key risk factors considered when assigning ratings; (2) mitigate any conflicts of interests in the methodology and review process and disclose with a clear rationale any updates to the methodology or process; and, (3) meet reporting obligations to the FCA with sufficient detail in a timely manner.
- Governance and oversight - The FCA expects CRAs to exhibit "sound governance through effective board oversight and internal controls structure to ensure an independent ratings process and methodologies that are free from conflicts of interest".
- Market and perimeter risks - Noting that CRAs are increasingly active outside of the regulatory perimeter, the FCA has stated it will "be proactive at the boundaries of [the] regulatory perimeter".
Direction of travel
The FCA's are and will continue to shine a light on CRAs to ensure their services are delivered in a fair, effective and transparent way. Two areas of particular interest are likely to be:
- ESG ratings - One way CRAs are becoming ever-more important is their role in the provision of ESG ratings. Opimas estimated that the global market for ESG data and ratings could exceed US$1 billion in 2021. CRAs' ESG ratings sit outside the FCA's regulatory perimeter. A key element of the FCA's ESG strategy is ensuring "integrity in the market for ESG-labelled securities, supported by the growth of effective service providers – including providers of ESG data [and] ratings…". The FCA recognises that as industry participants more fully integrate ESG considerations into their activities, they will be increasingly reliant on CRAs. Therefore, it is "important that these services are delivered in a fair, effective and transparent way". Despite this being outside the perimeter, the FCA states it will be proactive at the boundaries of the regulatory perimeter. See previous coverage, 'Greenwashing and information asymmetries: The FCA's direction of travel'.
- Senior Managers and Certification Regime - The FCA is working with HM Treasury on potentially extending the Senior Managers and Certification Regime to CRAs. Under current EU rules, CRAs are subject to a registration process. The purpose of this proposed change would be to deliver greater accountability and robust oversight. It would also likely ease the process of taking disciplinary action.
Given the crucial role CRAs play in facilitating the flow of capital, the FCA is likely to shine an ever brighter light on CRAs. The first regulatory warning signs have been signalled. As the era of cheap money begins coming to an end, markets and regulators will be interested in CRA's fair, effective and transparent responses.