March 28, 2011 / 11:35 AM / 9 years ago

Bank paper urges reform of credit rating agencies

LONDON (Reuters) - Rating agencies need to become more transparent and less dominant if they are no longer to pose a risk to the financial system, a Bank of England research paper argues.

A clock displays the time just after midday, opposite the Bank of England in the City of London March 10, 2011. REUTERS/Toby Melville

Debate about how to reform the ratings business has gathered pace since the financial crisis, which highlighted the agencies’ failings as well as conflicts of interest.

The U.S. Securities and Exchange Commission and the European Commission last year both introduced rules requiring greater disclosure of information in the hope of investment firms may opt to do their own research.

“Greater transparency in issuers’ financial information and improvements in financial firms’ capacity for internal assessment are pre-requisites for reducing reliance on ratings,” the paper argues.

“Since such improvements will take time, it is important that the momentum behind recent initiatives is maintained.”

The paper, written by five economists at the bank, does not necessarily reflect the Bank’s official view but will be closely scrutinised given the central bank’s new powers of financial regulation.

It argues that abolishing rating agencies is not an option. Other gatekeepers would emerge to fill the void with their own ratings-like research and advice. Subsuming their role into a single public rating agency would also be fraught with difficulty.

To reduce systemic risk, it argues, the hardwiring of rating agency decisions into financial contracts must be reversed and agencies’ governance and transparency must be improved. Deeper structural reform may also be needed, particularly in the structured finance segment of the market, to tackle conflicts of interest.

At present, ratings agencies such as Moody’s, Standard & Poor’s and Fitch, charge companies selling bonds, with investors getting the information free.

“Credit rating agencies can no longer be regarded solely as the providers of private goods to private markets. The crisis has demonstrated clearly that the public policy consequences of rating agencies’ franchises need to be taken into account,” it says.

Reporting by Christina Fincher; Editing by Ron Askew

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