CRAs and TRs—the way forward

CRAs and TRs—the way forward

How has the European Securities and Markets Authority’s (ESMA’s) supervision and regulation of credit rating agencies (CRAs) and trade repositories (TRs) developed and what is its likely future trajectory? Ewa Herman, an expert on European law, examines the future of CRAs and TRs in light if ESMA’s annual report.

What does the report cover?

On 16 February 2015, ESMA published its annual report and work plan for the direct supervision of CRAs and TRs. The report presents key elements of ESMA’s risk-based supervisory focal points in 2014 followed by the main priorities foreseen for 2015 towards an effective oversight of the supervised entities, improved regulatory standards and efficient risk analysis.

The report provides an overview of ESMA’s activities in 2014 as single supervisor of CRAs according to Regulation (EC) 1060/2009 (the CRA Regulation). In particular it:

  • refers to relevant guidelines, Q&As, regulatory technical standards (RTS) and technical advice
  • summarises the CRA registration and certification process hitherto
  • appraises complaints handling, investigation and enforcement as well as internal risk assessments based on the evaluation of industry trends and specific compliance risks of individual CRAs

In regard to TRs, the report emphasises ESMA’s direct and exclusive supervision accomplishments under Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR).

How has ESMA’s regulation of CRAs developed over 2014?

In the course of 2014, ESMA published relevant draft RTS on three key matters related to CRAs:

  • structured finance instruments
  • fees charged by CRAs to their clients, and
  • the European Ratings Platform

On 16 July 2014, ESMA issued a consultation paper on the periodic information to be submitted by CRAs to ESMA in order to ensure their efficient supervision based on high quality, relevant and timely data (see News 16/07/2014 132). After a public hearing on 15 October 2014, and a consultation which closed on 31 October 2014, the new guidelines are scheduled to be published in 2015. Moreover, 2014 reflected ESMA’s interpretation of the prior CRA Regulation amendments—introduced by Regulation (EU) 462/2013—included in the set of Q&As published by ESMA on 17 December 2013.

How has ESMA’s regulation ofTRs developed over 2014?

Based on provisions of EMIR, ESMA conducts the registration, supervision and recognition of TRs. During 2014, the Commission Delegated Regulation (EU) 667/2014 supplementing EMIR with regard to rules of procedure for penalties imposed on TRs by ESMA including rules on the right of defence and temporal provisions came into effect. Additionally, ESMA’s data validation guidance was published.

In 2014, the critical oversight challenge manifested itself in several incident notifications within the reporting obligation, which came into effect on 12 February 2014 and resulted in a total of 10 billion received reports. At the beginning of 2015, 300 million trade reports were submitted on a weekly basis by the relevant counterparties and processed by the six registered TRs.

What is the outlook for the regulation of CRAs and TRs in 2015/16?

The report sets ESMA’s biannual strategic aims for the CRAs’ supervisory practices. In 2015/16, ESMA will target the minimisation of conflicts of interest in the rating process and promote effective risk management. Consequently, strong governance and controls are set to come under ESMA’s scrutiny. ESMA will also focus on CRAs’ internal decision-making processes, as well as their business development processes, through on-going supervision, individual or thematic reviews or investigations.

In 2015, ESMA signalled an enhanced focus on TRs’ risk profiles, indicating a higher probability of infringement, lack of compliance and contagion effects. ESMA’s future supervisory efforts will be channelled towards tackling a number of issues related to the data quality identified in 2014. Thematic reviews and investigations will be carried out on:

  • inter-TR reconciliation
  • business continuity planning, and
  • the cost relatedness of TRs’ fees

Individual reviews and investigations will be conducted on:

  • TR systems software development lifecycle
  • data availability, and
  • regulators’ access to TRs and the confidentiality of TR data

What is the impact of the increased regulation affecting CRAs and TRs on practitioners?

For the first time enforcement actions have been brought against CRAs—in the EU in 2014 and US in 2015. Following an investigation triggered by an erroneous Standard & Poor’s (S&P) Global Credit Portal alert downgrading an unsolicited rating of France, on 3 June 2014, ESMA issued a public notice (in accordance with the CRA Regualtion, arts 23e(5) and 24). The notice reported the Board of Supervisors’ finding that the registered CRAs’, S&P’s Credit Market Services France SAS and S&P’s Credit Market Services Europe Limited, had committed the infringements listed in the CRA Regulation, Annex III.I, paras 12, 18. ESMA did not impose a fine. Several months later, on 21 January 2015, the US Securities and Exchange Commission (SEC) announced a series of federal securities law violations by S&P’s Ratings Services involving fraudulent misconduct in its ratings of certain commercial mortgage-backed securities resulting in a settlement exceeding $58m to settle the SEC’s charges in addition to $19m to settle parallel cases announced by the New York Attorney General ($12m) and the Massachusetts Attorney General’s office ($7m). ESMA is cooperating with the SEC in the supervisory colleges established for the three largest CRAs operating internationally—S&P, Fitch Ratings and Moody’s Investor Service.

Furthermore, it remains to be seen to what extent the CRA industry will be impacted in the future by ESMA’s current involvement in various projects of the Joint Committee of the European Supervisory Authorities (ESMA, the European Banking Authority and European Insurance and Occupational Pensions Authority).

Finally, ESMA’s report reveals a build-up of numerous notified TR exposures (eg disclosure of confidential information to non-authorised parties, service unavailability for market participants and/or supervisors, and a number of technical shortfalls implicating fundamental architecture inaccuracies) affecting the quality and confidentiality of the exchanged TR data, which might require taking further supervisory measures to improve TRs’ performance.

Ewa Herman has over 10 years of professional experience as a lawyer and in-house counsel gained in Germany, Poland and Spain. After graduating in law with specialisation in European and International Law from the European University Viadrina in Frankfurt (Oder), she completed the First and the Second Legal State Examinations in Berlin. Her legal clerkship at the Superior Court of Justice (Kammergericht) in Berlin included placements at the EMU, ECB, Euro Group and ECOFIN Division of the European Directorate of the German Federal Ministry of Finance and at the Representation of the European Commission in Berlin with a focus on financial reform and crisis resolution strategies at European Union, G20 states and EU-member states levels.

Interviewed by Barbara Bergin.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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About the author:

Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.

Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.