The Pfandbrief 2011 | 2012

Regulation of rating agencies: Time for new priorities?
Accepting External Ratings of Other Agencies
The agencies’ refusal to recognise external ratings by other rating agencies has been criticised.
Take derivatives, for example. Derivatives for hedging interest-rate and exchange-rate
risk on Pfandbriefe and the corresponding cover assets are recognised by the agencies only if
the derivative partner also has a rating from the relevant agency. At a time when many banks
no longer receive ratings from all three rating agencies, not least because of cost considerations,
this requirement soon proves to be a hindrance.
Moreover, the agencies require what is known as a contractual replacement, under which
the derivative contracts must stipulate that the derivative partner must search for a new derivative
partner, if it is no longer able to satisfy certain rating requirements itself. This “replacement
derivative partner” must also have a rating from the agency. This approach is also likely
to be problematic, at the very least, in terms of competition law.
The interim conclusion is that it is time to reform the existing Regulation governing rating
agencies by setting new priorities. In addition to increasing transparency with respect to the
models used, the agencies need to concentrate much more on communicating with other market
participants. The agencies’ refusal to recognise external ratings by third parties also needs
to be addressed.
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No Compulsory Additional Rating
However, the goal of avoiding conflicts of interest has been addressed as comprehensively as
possible in the Regulation, given the existing rating system. In our view, compulsory rating by
at least two agencies, which is currently under discussion, will not lead to any improvement.
We believe that this is the wrong approach, as it would increase even more the significance of
external ratings for regulatory purposes without providing sufficient benefits in return. Finally,
it would push up the costs and expenses of the institutions concerned. Such a requirement
would not increase competition either, since one of the three established agencies would probably
be commissioned to provide the second rating. Even if, as occasionally suggested, a foundation
were made responsible for awarding the rating contract, it would still be impossible to
avoid the established agencies. Because rating agencies rely on their good reputation and their
track record, a new agency would first have to develop both of these. It is inconceivable that a
foundation could compel issuers to award a rating contract to an unknown agency. The same
situation would arise if, as proposed alternatively, a rating foundation were set up to compile
its own ratings. Even a foundation of this kind would first have to develop a reputation for itself
before it would be able to provide ratings profitably or, at least, on a break-even basis. At the
same time, an attempt to develop a new agency should not be condemned to failure from the
outset.