18.1 Definition

This directive regulates credit rating agencies (CRAs) across the Single Market. The stated reason is that it contributes to the smooth functioning of the internal market while achieving a high level of consumer and investor protection (Art 1). Also—despite the unease of regulators about this—ratings continue to play an important role in the prudential regulatory framework, especially for banks, despite them having greatly contributed to the development of the financial crisis.

The regulation contains a number of annexes that provide detail on what is expected from rating agencies, notably on Independence and the Avoidance of Conflicts of Interest (Annex I), which contains parts on Organisational requirements (Section A), Operational requirements (Section B), Rating analysts (Section C), Presentation of ratings (Section D), and Disclosures (Section E). Annex II details the information required when applying for registration.

18.2 Scope

This directive applies to public ratings that are either made available to everyone, or that can be obtained via a subscription agreement. It does not apply to private or company internal ratings, and—importantly—neither does it apply to credit scores as they are being used in the consumer space (Art 2). A CRA whose registration has been accepted is referred to as an External Credit Assessment Institution (ECAI). To the extent that credit ratings are used by companies (eg banks, insurance companies etc.) for regulatory purposes they must have been issued or endorsed by an ECAI. Endorsement hereby refers to a specific process that ECAIs must follow to ensure that ratings issued by a third‐country agency are of equally high standard (Art 4). It is most often used in relation with an EU‐incorporated entity endorsing a non‐EU‐incorporated entity operating under the same umbrella. For example, US ratings are generally produced by a US entity, and are not eligible to be used in a regulatory context without endorsement.

18.3 Registration and Equivalence

CRAs incorporated in a Member State apply for registration with ESMA, in the language of that Member State as well as in a language customary in the sphere of international finance, ie probably in English. ESMA then considers the application together with the home regulator, and possibly a college of other regulators where the CRA is planning to become active (Arts 15–18). A registration fee commensurate with the cost incurred can be charged (Art 19). Registration can be withdrawn in the event of misconduct, or if the CRA has not issued new ratings for 6 months (Art 14). See also Annex II for more detailed information.

There is an equivalence process that allows ratings issued CRAs from third countries to be used in the regulatory context described in Article 4. For this, the Commission must have declared the third‐country regime equivalent, and the CRA must register with ESMA. Importantly, equivalence cannot be used if the CRA in question is systemically important in any Member State (Art 5).

18.4 General Operational Requirements

CRAs must be independent and avoid conflicts of interest (Art 6). Rating analysts must have an appropriate level of competence, and they can not participate in commercial discussions with employees of the entities they rate. Analysts must be rotated on a regular basis (Art 7). A CRA must disclose publicly the methodologies, models and key rating assumptions it uses in its credit rating activities, and shall subject its analysis to historical analysis and back testing. Methodology must be reviewed regularly—at least annually—and if methodology is changed, the likely impact must be disclosed immediately, and all affected ratings must be adjusted within at most six months, being marked as under review in the meantime (Art 8). CRAs cannot refuse to rate a deal that is relying on other agencies’ ratings, eg a structured finance deal where they have not rated all underlying securities (Art 8). See also Annex I, Section A–C for more detailed information.

18.5 Structured Finance Ratings

Structured finance ratings must be distinguished from corporate ratings by using a different symbol (Art 10.3) (note: this is considered important because whilst it is widely acknowledged that corporate and structured finance ratings are not equivalent, many by‐laws and investment mandates fail to make this distinction, leading to unnecessary ambiguity).

18.6 Unsolicited Ratings

A CRA must clearly disclose their policy on unsolicited ratings, unsolicited ratings must be marked as such, and the level of cooperation from the company must be disclosed (Art 10.4–5) (note: unsolicited ratings tend to be lower if the rated entity is not given the opportunity to provide non‐publicly available information, so unsolicited ratings can be used to nudge a company into requesting a paid‐for rating instead).

18.7 Disclosure and Transparency

Disclosure on ratings must be made in a timely and non‐discriminatory manner (Art 10). A CRA must make data on the historical performance available in a repository established by ESMA, where it will be publicly available (Art 11). It also must prepare an annual transparency report (Art 12). The disclosures under Arts 8–12 must be free of charge (Art 13). More details on disclosures are in Annex I, Sections D–E.

18.8 Role of EBA

EBA is working with the local regulators, third‐country regulators, and colleges of regulators in the manner prescribed by this regulation. It also from time to time issues guidance, and establishes a mediation mechanism to settle disputes. The usual data protection rules apply (Arts 21–35).