Rating Agencies and Regulation: The Insurance Industry between Scylla and Charybdis?

Transcription

1 Gesamtverband der Deutschen Versicherungswirtschaft e. V. Rating Agencies and Regulation: The Insurance Industry between Scylla and Charybdis? Dr. Michael Wolgast Head of Economics Department German Insurance Association (GDV) 13th Meeting of The Geneva Association s Amsterdam Circle of Chief Economists Amsterdam, 18 February 2011

2 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 2 Rating-Agencies Where do we stand? specific business model of CRAs insurers feeling uneasy about CRAs over many decades, important issues of concern some progress with IOSCO Code of Conduct Fundamentals for CRAs financial crisis brought up more general criticism of CRAs and ignited new discussion on role and regulation of CRAs global trend to implement strict regulatory framework for CRAs in addition: discussion on further measures in the field of CRAs (market structure, business model, use of ratings for regulatory purposes) consequences for the insurance industry?

3 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 3 General observation: Problems and imperfections of the market for ratings main competitive factor: reputation, usual competitive factors (price, service level) of far less importance incentives and opportunities to scrutinize rating agencies and impose sanctions for inferior quality of ratings or misbehaviour of rating agencies are insufficient main reasons: informational asymmetries (rated entities / CRAs / users of ratings) high potential for conflicts of interest high barriers to market entry / natural oligopoly market mechanism not fully functional, partial market failure

4 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 4 Key issues of concern for the German insurance industry (I) Conflicts of interest as far as possible, conflicts of interest should be eliminated (e.g. ban on advisory services to rated entities) remaining conflicts of interest must be managed adequately and disclosed (e.g. no involvement of analysts in fee negotiations) transparency of rating methodology main features of rating methodology must be transparent so that rating users can assess philosophy of a certain rating public discussion on rating methodology must be possible, e.g. consultation on methodology or major methodological changes

5 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 5 Key issues of concern for the German insurance industry (II) disclosure of type of rating, rating users should immediately recognize whether a rating is solicited or unsolicited the rated company participated in the rating process / the CRA was able to rely on internal information Interaction with rated entities prior notification of rated entities about the rating result and appeal process to minimise factual errors (integral part of quality management), adequate notification period internal information in case of unsolicited ratings must be confidential proper handling of complaints / adequate complaint management procedures

6 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 6 Key issues of concern for the German insurance industry (III) integrity of rating process and public statements high and consistent quality of ratings and of policies and procedures accuracy and appropriateness of public statements, e.g. avoid exaggerated remarks aimed at increasing publicity resources available for rating process / monitoring of ratings sufficient number and qualification level of analysts qualification level of rating analysts: special know-how required for insurer ratings, e.g. with respect to national legal framework, actuarial risks and group structures

7 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 7 Regulation of CRAs important initiatives CRAs traditionally subject to little formal regulation despite vital importance of ratings for functioning and stability of financial markets example of auditors / chartered accountants from 2003 on regulatory initiatives to establish minimum standards for CRAs and deal with shortcomings in rating markets, in particular: IOSCO Statement of Principles regarding the Activities of CRAs (2003) IOSCO Code of Conduct Fundamentals for CRAs (2004) CESR s voluntary framework for monitoring CRAs compliance with IOSCO Code (2006) U.S. Credit Rating Agency Reform Act (2006 / 2007) ECAI system (Basel II, 2007)

8 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 8 Impact of IOSCO Code major CRAs developed codes of conduct that largely incorporated the IOSCO provisions, with a few deviations only significant improvement of standards, e.g. with respect to transparency of methodology CRAs increasingly entered into dialogue with market participants however, shortcomings soon became apparent, e.g.: several Code provisions proved insufficient need for supervisory guidance on interpretation of provisions no enforcement mechanism

9 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 9 New discussion on CRAs triggered by financial crisis CRAs widely seen as one of the main culprits of the financial crisis manifold points of criticism inferior rating quality (especially structured finance products) conflicts of interest (e.g. combining consulting and rating services) lack of competition / dominance of Anglo-Saxon CRAs insufficient transparency of ratings and CRAs overreliance on ratings by market participants and regulators / supervisors systemic risk / procyclicality of ratings timing and communication (e.g. sovereign debt ratings)

10 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 10 Worldwide regulation of CRAs as a consequence global level: tightening of IOSCO Code (2008), G 20 decision on regulatory framework for CRAs (2009) European level: Regulation on CRAs (2009), amendment of Regulation on CRAs (2010) in most industrial countries introduction of new regulatory framework for CRAs (e.g. Japan) or tightening of existing rules (e.g. USA)

11 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 11 The new European registration and surveillance system for CRAs comprehensive requirements for quality and transparency, e.g. provisions to ensure high quality of ratings provisions to avoid or adequately manage conflicts of interest comprehensive disclosure requirements with respect to type of ratings, rating methodology, and rating performance requirements with respect to corporate governance implementation still ongoing more than 20 applications for registration by CRAs so far only one national CRA registered (Euler Hermes Rating) and one foreign CRA certified (Japan Credit Rating Agency) decision on registration of major CRAs expected by Q2/11

12 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 12 Impact of new EU Regulation full assessment not yet possible, however many improvements with respect to quality standards and transparency have already become apparent e.g. with respect to the ratings for German insurers, e.g. improvements of rating methodology further transparency of methodology and procedures improved disclosure of type of ratings withdrawal of most of the unsolicited ratings for German insurers 2006 today S&P 51 7 Moody s 2 0 Fitch 144 4

13 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 13 Discussion on additional measures in the field of CRAs strong criticism and extensive political discussion of CRAs activities continues multitude of proposals for additional measures European Union: European Commission s consultation paper of November 2010 major areas of reform measures under discussion: promoting competition between CRAs (e.g. new European CRA) alternative business models for CRAs new civil liability regime for CRAs special provisions for sovereign debt ratings avoiding overreliance on ratings by market participants and supervisory authorities

14 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 14 The new EU consultation on CRAs (I): Enhancing competition in the credit rating industry objective: expose global CRAs to more competition in order to reduce market power and improve rating quality proposed measures e.g. creation of new European CRA (public or private entity) provision of ratings by ECB or NCBs support for smaller national CRAs (e.g. reduction in barriers to entry) promotion of unsolicited ratings by new disclosure requirements

15 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 15 Enhancing competition in the credit rating industry: Assessment very limited scope for improvement in rating quality by way of increased competition rating market is a natural oligopoly, full competition not possible (significant economics of scale and scope, network effects) more competition does not always lead to better market results (rating shopping, quality problems of unsolicited ratings) risk of political influence on ratings threat of significant costs for rated entities and rating users (e.g. obligation to use additional ratings, new disclosure requirements) competition already enhanced by new regulatory regime

16 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 16 The new EU consultation on CRAs (II): Alternative business models objective: promotion of alternative business models to reduce conflicts of interest inherent in issuer pays model proposed measures e.g. creation of new investor-financed CRAs creation of public CRA establishment of Credit Rating Agencies Board that allocates rating mandates introduction of payment-upon-results model

17 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 17 Alternative business models: Assessment all possible business models subject to substantial conflicts of interest alternative business models difficult to establish, high costs risks of alternative business models, e.g. with respect to rating quality and availability of ratings regulatory system already includes many provisions to deal with conflicts of interest specific problems of public CRA / publicly created allocation mechanism for rating mandates payment-upon-results hardly feasible business models of CRAs should be left to the market, government interference not justified

18 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 18 The new EU consultation on CRAs (III): Civil liability of credit rating agencies objective: providing financial incentives for CRAs to ensure high quality of ratings proposed measure: European civil liability regime for CRAs

19 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 19 Civil liability of credit rating agencies: Assessment shortcomings of civil liability rules: difficulties in determining causality and amount of losses incurred civil liability of CRAs only in case of infringements of (regulatory) standards, only in case of intent or gross negligence CRAs already subject to civil liability in most European countries, no European approach needed negative impact of excessive civil liability for CRAs (e.g. rating availability) financial incentives should rather be part of the regulatory framework for CRAs, amendment of CRA Regulation already introduces substantial fines and periodic penalty payments in case of infringement of regulatory provisions

20 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 20 The new EU consultation on CRAs (IV): Special provisions for sovereign debt ratings objective: introducing specific requirements for sovereign debt ratings proposed measures e.g.: longer period for prior notification ban on solicited ratings for public entities increased disclosure of information more frequent reviews of ratings

21 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 21 Special provisions for sovereign debt ratings: Assessment issues of concern are similar for private and public sector issuers, therefore no justification for separate rules for sovereign debt ratings if there is a need for stricter rules, these should be discussed for all ratings

22 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 22 The new EU consultation on CRAs (V): Avoiding overreliance on ratings objective: reducing reliance on ratings by market participants and supervisory authorities, reducing procyclical effects of rating changes proposed measures e.g. requirement for investors to use at least two external ratings market based measures of credit risk as an alternative to assessments by CRAs in the regulatory context requirement for investors to internally rate securities additional disclosure requirements for rated entities so that market participants can form their own view (e.g. in the field of structured products)

23 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 23 Avoiding overreliance on ratings: Assessment important discussion, use of ratings should be reviewed market participants capabilities for risk assessment should be promoted, and whenever suitable alternatives to external ratings are available, these should be used in the field of regulation but: ratings will remain indispensable, suitable alternatives often not available or very costly concrete measures proposed mostly not expedient for insurance industry European discussion on use of ratings should be part of Solvency II exercise, no separate discussion

24 Gesamtverband der Deutschen Versicherungswirtschaft e. V. 24 Overall policy conclusions new European regulatory regime for CRAs created in 2009 already deals with many, if not all of the issues of concern of the insurance industry a strict supervision of CRAs and a continuous further development of regulatory framework could constitute the appropriate instrument to ensure high quality standards of CRAs additional structural reforms (e.g. new European CRA, measures to enhance competition, alternative business models) not helpful: very limited benefits, but substantial costs and risks from the point of view of the insurance industry review of use of ratings by market participants and supervisory authorities welcome, but ratings will probably remain important for the industry

25 Gesamtverband der Deutschen Versicherungswirtschaft e. V. Rating Agencies and Regulation: The Insurance Industry between Scylla and Charybdis? Dr. Michael Wolgast Head of Economics Department German Insurance Association (GDV) 13th Meeting of The Geneva Association s Amsterdam Circle of Chief Economists Amsterdam, 18 February 2011