July 16, 2010 / 3:45 PM / in 7 years

Canada unveils rules for credit rating agencies

TORONTO (Reuters) - Canada proposed new regulations for credit rating agencies on Friday to boost investor confidence and prevent conflicts of interest that critics say may have contributed to the global credit crisis.

The new rules on agencies that assign risk ratings to corporate debt issues are the result of a pledge made by Canada and the other G20 economies to overhaul financial regulation.

At the heart of the proposals is a requirement that credit rating agencies apply to become so-called “designated rating organizations,” or DROs.

The Canadian Securities Administrators (CSA), the umbrella organization for the country’s 13 provincial and territorial securities watchdogs, would then require designated agencies to establish policies and procedures to manage conflicts of interest.

“Many investors consider credit ratings as one of the factors in making investment decisions, and ratings continue to be referred to within securities legislation, so it is important to develop a formal regulatory regime for the oversight of credit rating organizations,” said Jean St-Gelais, chairman of the CSA.

"This CSA initiative is consistent with international developments in addressing the oversight of credit rating agencies, which can have a significant impact upon financial markets," he said in a statement posted on the CSA's website. (here)

The measures are meant to reduce the risk of conflicts of interests at credit rating agencies that are paid by the issuers whose debt they rate.

The new regulations will give Canadian regulators the authority for the first time to review and demand changes to the way agencies operate.

The biggest credit rating agencies operating in Canada include Toronto-based DBRS; Standard & Poor‘s, owned by McGraw-Hill Cos, and Moody’s Investors Service, owned by Moody’s Corp.

“DBRS is already regulated in the U.S. and soon will be in Europe, and believes it has laid the foundation to meet these new Canadian rules,” Canada’s only domestically owned and based credit rating agency said of the report on Thursday.

Moody’s and S&P said in separate statements that they were both reviewing the proposal.

Credit agencies came under attack during the global economic crisis after they failed to spot problems with debt that was linked to bad mortgages. The implosion of these securities helped contribute to the global financial crisis.

“Clearly, they have to be audited from outside if people are trading and buying and selling securities on the basis of their ratings only. They have horrendous power and it has to be monitored,” said Thomas Caldwell, chairman of wealth manager Caldwell Financial Ltd.

The CSA said it will not oversee the content or methodology of credit ratings, a claim that perplexed Eric Kirzner, a securities expert and professor at the University of Toronto.

“I don’t see how they would exercise direct oversight without getting into the methodology employed,” he said.

He lauded the move to increase scrutiny, however, and said it was worth any added costs.

“(The agencies) did their share of damage in the crisis, and the cost of that is that regulation becomes more expensive,” Kirzner said.

As part of the new regime, DROs would have to set up practices to prevent inappropriate use of information, appoint a compliance officer and make an annual filing, among other requirements.

The new rules are subject to changes after a comment period that ends in October.

“It’s a positive step forward and a long time coming,” said Philip Anisman, a Toronto securities lawyer. “The real questions will have to do with its administration.”

“The adequacy of the regime will depend on the enforcement and compliance mechanisms adopted by the regulators.”

Closer oversight of credit rating agencies was a pledge made by the Group of 20 emerging and developed economies at a Toronto summit in June, and is part of a global move to overhaul financial regulation.

Reporting by Pav Jordan and Jennifer Kwan, additional reporting by Cameron French; editing by Rob Wilson

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