SWEEPING CHANGES to the regulation of credit ratings are set to be proposed by Brussels that would deal a blow to the business models of the big three agencies that issue them.

Under one of the most contentious proposals, European regulators would be able to suspend credit ratings of a country undergoing a bailout.

But that measure is just one of many reforms sought by the European Commission, according to a draft of the proposals seen by the Financial Times.

Brussels is also seeking to force issuers of financial products in Europe to regularly change the rating agency they are using, to open up competition and avoid conflicts of interest. “The credit rating agency engaged should not be in place for more than three years or for more than a year if it rates more than 10 consecutive rated debt instruments of the issuer,” the draft proposes.

Before being able to work for the same company or bank again, agencies would be compelled to sit out a four-year “cooling-off” period. This would rob agencies of some of their more stable revenues and business relationships.

The reforms also propose giving wide-ranging powers to Esma, the European markets regulator, to approve rating methods and ban sovereign ratings in “exceptional situations”.

“In order to prevent that credit rating agencies issue sovereign ratings which do not accurately reflect the situation of the country concerned and would cause negative spillover effects to other countries, Esma should be granted the power to temporarily restrict the issuance of credit ratings in exceptional, precisely defined situations,” the draft argues.

There is some confusion over how such a ban could be enforced, as Esma would be unable to stop agencies outside the EU from issuing sovereign ratings on countries that were in a bailout programme.

Credit rating agencies are also likely to argue that a suspension would amount to a restriction of free speech, as they consider their ratings to be opinions.

The changes, if adopted by the European parliament and EU states, would also have a big impact on the customers of credit rating agencies. Companies and banks issuing financial instruments will be required to obtain two ratings and will see the fees they pay published.

Under the reforms, Esma will be asked to develop technical standards, to be endorsed by the commission, in order to harmonise rating scales and the presentation of reports. New rating methodologies, or adjustments to existing models, will have to be open to consultation and submitted to Esma for “approval”. – (Copyright The Financial Times Limited 2011)