December 7, 2011

EU Watchdog Growls at Ratings Agencies

Investigation under way; could result in penalties, license revocation

The hounds are on the scent. The European Union agency that presides over the ratings actions of the likes of Moody's, Standard & Poor's, and Fitch Ratings has begun an investigation into how they arrive at rankings for sovereign bonds and other debt, and it warns that if wrongdoing is uncovered, the penalties could be severe–all the way up to and including withdrawal of their licenses.

Reuters reported Wednesday that officials from the European Securities and Markets Authority began visits at the beginning of November to not just the big three ratings agencies, but some of their smaller competitors. They will continue to conduct their investigation through the end of December.

The investigation has taken on added significance after S&P's warning on Monday that it might downgrade nearly the entire eurozone—15 countries were warned that their ratings were in danger, as previously reported by AdvisorOne.com. The timing of the warning drew criticism from European leaders, as well as accusations that it was politically motivated.

European Central Bank governing council member Christian Noyer called S&P's methodology more political and less concerned with economic fundamentals. Other eurozone officials have said the ratings agencies have made the region's debt crisis worse. Certainly the drumbeat of downgrades has rattled investors.

Previously ratings agencies operated with no chance of challenge to its decisions. This audit by ESMA is the first European attempt to change that, and to police the hitherto-independent industry.

The ESMA spokesman was quoted saying on Tuesday, "We will publish a report on the outcome of our first on-site inspections of ratings agencies." He added that the report would be issued in April at the latest, adding, "Our inspectors are examining how the rating agencies conduct their business and arrive at ratings. If we were to find wrongdoing, ESMA has the power to fine agencies, suspend their ratings and we could even withdraw their license."

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