The role of credit rating agencies in the wake of the 2008 financial crisis

Abstract

Credit Rating Agencies ('CRAs') are blamed for playing a major role in triggering the 2008 global financial crisis and failing to avert a meltdown in global financial markets. CRAs have displayed an air of invincibility, having always avoided any legal liability and not being subjected to any robust regulation. These shortcomings have increased the necessity for reform. Chapter 1 gives a brief history of CRAs and their regulation. It explains the economic function of credit ratings ('CRs) and their role in an organised capital market in ensuring that debt capital is raised at sufficient quantity at the right cost, with due regard to investor protection. Chapter 2 reviews relevant US principles and case law, foremost amongst which the constitutional protection available to the press. Some recent case law indicates that the legal ground may be shifting. A critical exercise of CRA practice and weaknesses displayed follows in Chapter 3: conflicts of interest (in particular the issuers-pay-model), lack of competition and lack of a global harmonised system of regulation, although CRAs also have some valid defences. Chapter 4 reviews the International Organisation of Securities Commissions ('IOSCO') Code, a template for cross-border supervision and national regulatory legislation. Indeed, the Code provisions aimed at avoiding and managing conflicts of interest and ensuring the integrity and quality of the rating process and the responsibilities of CRAs to the investing public are found in reform legislation enacted in the major finance capitals in the European Union ('EU'), Australia and Japan, and those currently being debated in the US. Chapter 5 exposes CRA excesses evidenced in US Congress testimony, also outlining the provisions of the US Congress Bills currently under consideration. Chapter 6 considers the first comprehensive regulatory legislation applicable in the EU relating to CRAs. Chapter 7 covers Australia's regulatory reform. Chapter 8 considers interesting regulatory policy alternatives considered in Canada. Chapter 9 deals with the reforms introduced in Japan. Chapter 10 considers CRA relevance to Malta. Although Malta has no indigenous CRAs, the financial scenario is peppered with references to CRAs. Aspects of investor protection are also considered and some “solutions” proposed. Chapter 11 attempts some concluding reflections with the hope that CRA reform ensures that past mistakes are not repeated. Indeed CRA reform is not only desirable, but also essential, for the CRAs themselves, as reform is the only way to give them that credibility which is the rationale for which they exist in the first place.