Consultation Paper. Ref.: CESR/04-612b. 31 January 2005

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1 Z ENTRALER K R E D I T A U SSCHUSS MITGLIEDER: BUNDESVERBAND DER DEUTSCHEN VOLKSBANKEN UND RAIFFEISENBANKEN E.V. BERLIN BUNDESVERBAND DEUTSCHER BANKEN E. V. BERLIN BUNDESVERBAND ÖFFENTLICHER BANKEN DEUTSCHLANDS E. V. BERLIN DEUTSCHER SPARKASSEN- UND GIROVERBAND E.V. BERLIN-BONN VERBAND DEUTSCHERHYPOTHEKENBANKENE. V. BERLIN Comments of the Zentraler Kreditausschuss 1 on CESR s technical advice to the European Commission on possible measures concerning Credit Rating Agencies Consultation Paper Ref.: CESR/04-612b 31 January The ZKA is the joint committee operated by the central associations of the German banking industry. These associations are the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR), for the co-operative banks, the Bundesverband deutscher Banken (BdB), for the private commercial banks, the Bundesverband Öffentlicher Banken Deutschlands (VÖB), for the public-sector banks, the Deutscher Sparkassen- und Giroverband (DSGV), for the savings banks financial group, and the Verband deutscher Hypothekenbanken (VdH), for the mortgage banks. Collectively, they represent more than 2,500 banks.

2 - 2 - A. General observations Within the framework of the discussion on the role and activities of credit rating agencies, the German banking industry has always emphasised the need to ensure the reliability of company appraisals and credit ratings communicated externally by CRAs. Credit ratings play an important role in making financial markets efficient. They promote market depth and market liquidity by allowing a comparison of issuers credit standing. They are of great importance to investors, since they are based on comprehensive analyses and in most cases on information that is not available to investors. Moreover, external credit ratings are being taken increasingly by legislators and central banks as a yardstick. Against this background, external credit ratings are frequently a major factor in investors investment decisions. Banks are doubly affected by the activity of credit rating agencies: As investors and managers of debt issues, they expect to receive meaningful, reliable information about the credit standing of issuers. As issuers, they are equally interested in accurate ratings that can be used in the capital markets as a reliable basis for investment decisions. An essential condition for achieving this goal is, in our view, a high-quality, objective and transparent credit rating process that takes due account of the legitimate interests of the all parties involved in the rating process. We believe that CRAs already do a good job in this respect; they play an important role in eliminating information asymmetry in the capital markets. At the same time, we feel there is potential for improving the credit rating process and thus also the quality of ratings. Against this background, we expressly welcome it that the European Union is addressing this important issue and that the European Commission and CESR are endeavouring to consult closely with the market participants affected in their courses of action. At the end of last year, IOSCO presented its Code of Conduct Fundamentals for Credit Rating Agencies. We regard this code as a sensible approach. It contains the basic requirements for CRAs and constitutes an internationally accepted standard. The code should serve as the basis for the further treatment of the issue at European level. This would also take account of the fact that a considerable and steadily growing proportion of financial transactions are cross-border transactions and that the large CRAs are international companies. This does not rule out the Code containing more specific or expanded provisions when it is implemented in the European Union. However, the primary aim should always be ensuring an efficient credit rating process for European investors. European rules for CRAs should not, at any rate, lead to ratings of European companies being regarded by investors as poorer in quality than ratings of companies from other regions. This would have negative consequences for the terms of European debt issues in the marketplace.

3 - 3 - The yardstick for all measures contemplated should, in our opinion, be safeguarding the legitimate interests of issuers and investors, while preserving the independence of credit rating agencies. This means in particular enforcing the existing requirements for CRAs to safeguard these interests and putting in place mechanisms to ensure compliance with these requirements. B. Replies to the individual questions May we reply as follows to the questions contained in the consultation document: I. Introduction 1. Do you agree with the definition of credit rating agencies? If not, please state your reasons. We agree with the definition proposed by CESR, which corresponds with the IOSCO definition. 2. Do you agree with the definition of credit ratings? If not, please state your reasons. We agree with the definition. 3. Do you agree with the definition of unsolicited ratings? If not, please state your reasons. We suggest replacing the phrase "where the initiative has not been taken by the issuer" by "where the rating is not covered by a mandate". It is not always absolutely clear in practice by whom the initiative has ultimately been taken. Moreover, only a rating that is covered by a mandate is likely to be based on the comprehensive information normally required for ratings. 4. Do you think that issuers should disclose rating triggers included in private financial contracts? The use of rating triggers is a matter for private contractual arrangements and should in principle be regarded as such. Should such contractual arrangements give rise to or indicate problems concerning the future solvency of issuers which affect third parties the buyers of debt securities offered by these issuers the provisions of the Prospectus Directive apply. We do not believe that a general disclosure requirement is appropriate, particularly as, where many issuers are concerned. The existence of rating triggers need not automatically lead to a deterioration in their liquidity

4 - 4 - position following a downgrade. Moreover, there is the danger of double rating, as credit rating agencies usually take rating triggers into account when rating companies. 5. Do you think that the use of ratings in European legislation should be encouraged beyond the proposed framework for capital requirements for banks and investment firms? If yes, please provide examples. We regard the trend discernible both in the US and Europe towards making ratings the basis for legal standards as problematic. If legislators, regulators or central banks deliberately use assessments delivered by credit rating agencies as a yardstick in some areas, there is the danger of regulation of major spheres of economic activity being effectively taken away from public authorities and transferred at least indirectly to private institutions which have not been subjected to sufficient state control thus far. Moreover, this would only further increase the strong influence that CRAs already have on markets and companies. Finally, reference in laws and regulations to ratings issued by CRAs that are recognised by regulators makes it more difficult for new CRAs to gain entry to the rating market, thus impeding competition in a steadily growing market. For this reason, the use of external credit ratings should not be encouraged beyond the proposed framework for capital requirements for banks. Instead, past and future laws and regulations should be reviewed critically in each and every case to determine whether other ways of achieving the goals pursued could be found. This could make it easier for new competitors to gain entry to the rating market and help to limit CRAs scope of influence to their actual field of activities. II. Competitive Dimension: Registration and Barriers to Entry 1. Do you think there is a sufficiently level playing field between CRAs or do you think that any natural barriers exist in the market for credit ratings that need to be addressed? The international external rating market currently has an oligopolistic structure, with the market dominated by three big credit rating agencies. There are a number of reasons for this state of affairs: Setting up a large, internationally competitive CRA is extremely capital-intensive. Such investment takes a long time to pay off. This is because the basis for a CRA s reliability and credibility and thus its competitive position is its track record, in which it should be able to demonstrate that it has a long history of issuing ratings that accurately reflect the credit standing of the companies and countries it has rated. This raises barriers to market entry for new competitors that can only be removed to a limited extent by legislation. It is therefore paramount to ensure that no additional barriers to market entry are created.

5 - 5 - The aim should therefore be that the entries of additional competitors, e.g. following the possible recognition of CRAs in future for regulatory or other legally relevant purposes, and the establishment of these competitors on the rating market remain possible. The conditions for the market entry of additional competitors must, on the other hand, continue to ensure that ratings are of the quality needed for a functioning capital market 2. Do you believe that coverage of certain market segments or certain categories of economic entity (such as SMEs) may be sub optimal? Are there measures that regulators could use to affect this scenario? Which are they, and would it be appropriate to use them? Good-quality ratings have their price. Even if there were a larger number of credit rating agencies competing keenly with each other, the cost of obtaining a rating would probably still be too high for many SMEs compared with the benefits they would receive in terms of financing. At the same time, it is also unclear how many SMEs require external credit ratings. Even allowing for continued securitisation, their number is likely to remain small. The market trend will first have to show whether a bigger demand is feasible. We therefore do not see any need for action by regulators to ensure wider market coverage with ratings. III.Rules of Conduct Dimension Interests and conflicts of interest 1. To what extent do you agree that in order to adequately address the risk that any conflicts of interest might adversely affect the credit rating it is sufficient to have the credit rating agency (i) introduce and disclose policies and procedures for management and disclosure of conflicts of interests, and (ii) disclose whether the said policies and procedures have been applied in each credit rating? Credit ratings can only help to improve the efficiency of the financial markets if it is guaranteed that the ratings issued by credit rating agencies for countries, issuers or individual debt issues are not affected by other interests. It must therefore be made sure that conflicts of interest are in principle avoided or where this is not possible or would be unreasonable at least disclosed. CRAs should therefore establish appropriate policies and procedures to ensure that conflicts of interest are avoided from the outset or are otherwise disclosed. Possible disclosure rules could be based on the provisions of the Commission s Market Abuse Directive (2003/6/EC) and Implementing Directive (2003/125/EC). Disclosure of whether the policies and procedures have been applied in each credit rating would make sense in our view if and insofar as these internal policies and procedures are not based on binding legal provisions but on voluntary decisions by

6 - 6 - rating agencies, since in this case the market needs such information to be able to exercise a minimum of control. If, on the other hand, European legislators opt for regulation of this area involving external control, there is no need for such disclosure. 2. Do you consider that to adequately address the risk that the provision of ancillary services might influence the credit ratings process it is necessary to prohibit a credit rating agency from carrying out those services? If your answer is yes, how would you address the entry barriers that could be created by imposing such a ban? We believe that the provision of additional services by credit rating agencies besides rating creates a potential conflict of interests between them and issuers or third parties. Managing this should be one of the duties of CRAs. While a complete ban on providing such ancillary services would be an effective instrument, it would probably be too stringent. Instead, consideration should be given to establishing special rules for handling any such potential conflicts of interest that may arise in the business of CRAs (see reply to Question 4). 3. Do you think that structured finance ratings give rise to specific conflicts of interest that should be addressed in CESR's advice to the Commission? Structured finance may give rise to specific conflicts of interest, as the rating of such issues can differ according to the way they are structured and the information a credit rating agency has about the rating implications of different combinations of the underlying assets is thus important for issuers. However, general rules and disclosure requirements ought to cover such special cases as well. In addition, it would have to be clarified which rating methodologies are covered by the term structured finance ratings. 4. To what extent do you agree that in order to adequately address the risk that the provision of ancillary services might influence the credit ratings process it is sufficient to have the credit rating agency (i) introduce and disclose policies and measures managing and disclosing multiple business relationships with issuers in general and the issuer being rated in particular, and (ii) disclose whether the said policies and procedures have been applied in each credit rating? We believe that a requirement for credit rating agencies as set out under (i) is appropriate. This includes in particular organisational duties to ensure a strict separation of ratings business from ancillary business in functional, physical and personnel terms (through the use of firewalls or Chinese walls). It would also make sense to require CRAs, when publishing ratings, to disclose whether the issuer concerned or any company competing with it has used other services provided

7 - 7 - by them, in addition to rating, within a certain period. Disclosure along the lines of (ii) of whether the said policies and procedures have been applied in each credit rating would be advisable in our view if and insofar as these internal policies and procedures are not based on binding legal provisions but on voluntary decisions by CRAs (see reply to Question 1 above). However, to avoid misunderstandings, only CRA services that a company has made use of for purposes of its own, but not those that it has obtained for third parties within the course of its normal business relations, should be disclosed. This is because all banks conducting investment banking are regularly instructed by their issuing clients to obtain a credit rating for them as well from a CRA when they launch an issue. This means that these banks pay CRAs not only for their own ratings and those for the debt issues they launch but also for obtaining ratings for their clients. If the payments for ratings obtained on behalf of clients were to be disclosed as other services to banks, outside third parties would get a completely wrong picture. 5. To what extent do you agree that in order to adequately address the risk that an issuer paying for a credit rating might influence its rating it is sufficient to have the credit rating agency (i) introduce policies and procedures, including but not limited to the introduction of a fee scheme, (ii) disclose its fee scheme and (iii) disclose whether the fee scheme has been applied in each credit rating? Credit rating agencies prime business interest is in being paid by the issuers they rate. Theoretically at least, it is possible that the published rating may be better than the rated company s actual risk situation, e.g. in order to secure further requests for rating. In practice, however, this has not been the case thus far. We believe that there are two reasons for this: (1) The risk of a loss of reputation is sufficient incentive for CRAs to issue ratings based on objective criteria and (2) the fact that individual issuers account for only a very low share of their turnover means that there is no question of CRAs being financially dependent on them. We therefore do not feel that individual remuneration of ratings by issuers is a pressing regulatory problem. At the same time, we believe that a fee scheme which issuers can understand is absolutely essential. Moreover, the analysis and pricing departments should be strictly separated within CRAs by means of robust Chinese walls. We are thus in favour of disclosure of clear fee schemes. 6. In order to deal with issues related to unsolicited ratings, to what extent do you agree that it is sufficient to have the credit rating agency (i) introduce and disclose policies and measures with regard to issuing unsolicited credit ratings and (ii) disclose when a particular rating has been unsolicited? There is the danger that unsolicited ratings may misrepresent a company if they are based solely on publicly accessible information which is not sufficient, particularly in restructuring phases for

8 - 8 - example, to allow an accurate assessment of the company s financial situation. To, on the one hand, create the required transparency for investors and, on the other hand, to ensure that unreasonable pressure is not put on issuers to improve their ratings by mandating a credit rating agency, we feel it is necessary to provide at least for a disclosure requirement for unsolicited ratings as set out under (ii). It should be disclosed whether the rating is based solely on publicly accessible information or whether it also includes inside company information. 7. To what extent do you agree that in order to adequately address the risk that any financial or other link between a credit rating agency and an issuer might influence the credit ratings process it is sufficient to have the credit rating agency (i) introduce policies and measures managing and disclosing financial links or other interests between a credit rating agency and issuers or its affiliates or investments in general and the issuer or its affiliates or investments being rated in particular, (ii) disclose the said policies and procedures and (iii) disclose whether the said policies and procedures have been applied in each credit rating? We believe that conflicts of interest which credit rating agencies may face as a result of legal or financial links with other companies should at least be made subject to a disclosure requirement as set out under (ii). This might at first apply to rated issuers who have shareholdings in CRAs and vice versa or where intercompany links exist between both, as a rating may influence the market value of a company and that of its parent company, as well as the price of outside capital. Against this background, CRAs should have appropriate arrangements in place to prevent conflicts of interest arising with the mandated rating analysts or the members of the rating committee, e.g. through their holding financial instruments relating to the client or its competitors. Conflicts of interest may also arise if a CRA that belongs to a group rates an issuer who is an important business partner of the CRA itself or other parts of its group or if, conversely, the rated issuer is an important competitor of a company affiliated to the CRA or an important business partner of the group. Fair Presentations 1. To what extent do you agree that in order to adequately address the risk that lack of sufficient or inappropriate skills might lead to poor quality credit ratings it is sufficient to have the credit rating agency (i) introduce policies and measures managing and disclosing levels of skills of staff, (ii) disclose the said policies and measures and (iii) disclose whether the said policies and measures have been applied in each credit rating?

9 - 9 - To ensure meaningful, high-quality ratings, the employees of a credit rating agency involved in the rating process must have qualifications that are appropriate to their function and position. Given that the market is currently dominated by three large, international CRAs, it should be noted in particular that ratings must take adequate account of the specificities of the legal and economic environment, ownership structure and business model of a rated issuer. This presupposes that the analysts and rating committee members responsible for rating are, among other things, sufficiently familiar with the relevant national laws and regulations in force in the issuer s home country (and possibly with directly applicable EU law) so that they are able to properly assess the information included in ratings. CRAs should therefore implement, and disclose, policies and procedures which ensure that their rating analysts in particular are suitably qualified. 2. Do you have any alternative approaches to address the actual or potential risk that lack of sufficient or inappropriate skills might lead to poor quality credit rating assessments? No. 3. Do you think that undisclosed methodologies could lead to biased credit ratings or to biased interpretation of credit ratings? Issuers and investors require comprehensive information on rating methodologies to be able to interpret ratings properly. This information allows them to determine which aspects or weaknesses are particularly important to credit rating agencies and which factors were crucial in a rating. Inadequate information on rating methodologies may, on the other hand, cause investors and issuers to misinterpret ratings and thus lead to fundamentally unjustified market responses. Theoretically, there is also the risk that rating methodologies which are not transparent enough may lead to biased ratings, as insufficient information to issuers and investors on these methodologies tends to give CRAs more scope for individual assessment. Transparent rating methodologies and procedures are therefore extremely important for both investors and rated issuers. Besides providing comprehensive general information on their rating procedures and methodologies, CRAs should, for example, make clear which methodologies they have applied to assess individual circumstances substantially influencing a rating result and whether and to what extent these methodologies and procedures have changed in specific cases or in general compared with previous ratings.

10 Moreover, particularly to ensure that rating decisions can be understood later and to allow them to be reviewed regularly or in specific cases, the introduction of a requirement for CRAs to keep a record of rating processes would be welcomed. Such a requirement would at the same time serve to ensure that all CRAs have the same basis for reviewing rating methodologies based on historical, empirical data. It should, however, be remembered in this connection that, although ratings are largely objective, they still contain subjective opinions by CRAs. In connection with the methodologies applied by credit rating agencies, a further problem should be noted: Analysts at CRAs are usually divided into different teams. There are, for example, separate teams of experts for rating structured products such as residential mortgage-backed securities (RMBS) and for rating banks. The latter are, for instance, also responsible for rating mortgage bonds. Given the complexity of products and markets, this certainly makes sense. However, there are also similarities between products. It is therefore essential that overlapping issues are treated in the same way. In our experience, however, this is not always the case. Even if teams exchange information and cooperate to a limited extent, there is still the danger that different standards are applied to similar requirements (e.g. to the regulatory environment). This may hinder fair competition between individual products. To avoid any distortion of competition due to rating teams applying different standards or weightings, it should be ensured that similar assessment criteria are applied to similar products, without ignoring the special features of each product. 4. Do you see more advantages or disadvantages in the regulation of CRAs methodologies by securities regulators? Please describe the advantages and disadvantages that you consider and which is the best way of dealing with them. Do you believe that this regulation would contribute in some ways to lead to common global standards for CRAs? Regulation of credit rating agencies methodologies should, if anything, be confined to general requirements that each rating methodology can be expected to comply with. In particular, rating methodologies should be systematic, precise, and purely fact-based; they should also take into account the specificities of the group of issuers, market or market segment and type of product concerned and of atypical cases; where possible, rating methodologies should also allow their objective validation by means of historical, empirical data. Further regulation specifying in detail how rating methodologies must be designed would not make sense in our view, as this would hinder both competition between CRAs for the best system, which is important for improving rating, and the adjustment of methodologies to changing market conditions. Such detailed regulation would therefore be more harmful than helpful for ratings as a reliable medium of capital market information.

11 Do you believe provisions of the IOSCO Code are sufficient, in terms of rules on CRAs methodologies and the corresponding disclosure? Do you believe that CRAs should disclose to issuers changes in methodologies before starting to use new methodologies? We expressly endorse the thrust of the provisions of the IOSCO Code on this point. At the same time, we believe that they need to be improved in two areas: For one thing, the provisions remain very general particularly on the question of disclosure of methodologies to issuers and investors and, for another thing, they are only guidelines or principles which credit rating agencies are to be left to flesh out and apply in individual cases. The legitimate interests of issuers and investors would be better served by clear, enforceable rules. We feel it is right and also important that CRAs should be required to disclose changes in their rating methodologies and criteria to issuers and investors before they start to use the new methodologies. Both rated issuers and investors rely on the fact that, when changing ratings or taking other rating action, CRAs apply the same standards as when publishing previous ratings and they assume this to be the case when comparing ratings and assessments of the long-term performance of an issue or an issuer. If this is not the case, investors must be given the opportunity to take this into account in their investment decisions and issuers must also be given the chance to adapt accordingly. Besides simply being informed about changes in rating methodologies, the issuers affected should in principle be given the opportunity to comment on the proposed changes. This ensures that credit rating agencies take into account market expertise when establishing their rating methodologies and criteria and that their attention is drawn, where necessary, to special features of a market or product that they may have overlooked when developing new methodologies or criteria. While there can be no doubt that CRAs decide alone on the methodologies and criteria they apply, it is in their interest to take such comments into account in order to avoid any methodological errors. The aforementioned requirements for CRAs would greatly help to ensure the quality of ratings and therefore not weaken but strengthen protection of investors. 6. Do you believe that regulation should concern all aspects of CRA s methodologies? How appropriate is the choice of explicitly regulating the four proposed issues (disclosure and explanation of the key elements and assumptions of a rating, indication of some forms of risk warning, rules on updating of ratings and the inclusion of some market indicators within a rating opinion)? Would you deal with these issues by self-regulation? As already explained in our reply to Question 4, regulation of credit rating agencies methodologies should be confined to principles. At the same time, it is important that issuers and

12 investors are informed about how rating results are obtained, i.e. which methodology is applied. Besides the points set out in our reply to Question 4, we therefore believe that full disclosure of rating methodologies is essential, particularly the following aspects: Definition of rating methodologies and criteria: CRAs should define and disclose in advance the rating methodologies and criteria that are applied in rating processes. Weighting of rating criteria: CRAs should inform clients about how the various rating criteria are currently weighted and how they influence the rating result (If a weighting is not quantifiable, CRAs should present their results on a graded scale); the same goes for the presentation of a rating report. Disclosure and quality of research data: CRAs should allow clients to access research data concerning them (including information on markets and other companies) which is to be or has been included in rating decisions, provided this does not affect their duty of confidentiality towards third parties. They should also ensure that the quality of the research data is maintained at a high level. On the other hand, we do not think it is necessary to devote any attention to certain market indicators in the presentation of a rating result. Rating is a formalised process that is designed to measure the future solvency of companies or countries. Although market prices do include investors credit assessment as well, they are also determined by other factors (e.g. market liquidity) that are not directly connected with the quality of an individual issuer. Relationship between issuers and rating agencies 1. Do you consider that the combination of the requirements of the Market Abuse Directive in this area and the requirements of the current version of the IOSCO Code adequately address the issue of access to inside information by CRAs? The issue of access to inside information by credit rating agencies is, generally speaking, addressed adequately by the IOSCO Code and the provisions of the Market Abuse Directive. 2. What is your view on requiring an issuer to itself disclose an imminent rating change where it has been advised of this by a CRA and where the rating announcement may itself amount to inside information in relation to the issuers' financial instruments? Responsibilities for disclosing inside information concerning an (imminent) rating change or other rating decision should, in principle, lie with issuers themselves. Rating changes are made by credit rating agencies. Their disclosure is in principle therefore the job of CRAs as well. While imminent

13 rating changes are inside information for issuers themselves, they only really become hard inside information once the rating process has been completed and the rating report and the wording of the press release have been agreed between the issuer and the CRA. CRAs are then required to disclose the result immediately thereafter. To ensure that the information communicated to the capital market is understandable and not misleading, issuers should therefore not be obliged to disclose an imminent rating change. The Market Abuse Directive already provides a means of implementing such an approach in our opinion. To avoid any legal uncertainty, this should, however, be expressly made clear in any regulation of this area. 3. Do you consider that the requirements of the Market Abuse Directive in this area sufficiently address the risks that inside information might be disseminated, disclosed, or otherwise misused? During the rating process, credit rating agencies gain access to a wealth of information from issuers whose confidential treatment can be of substantial commercial importance to these. This goes not only for inside information as defined under Article 1 of Directive 2003/6/EC (Market Abuse Directive) but also for other industrial and trade secrets, along with all related information. It must therefore be ensured that CRAs handle all non-public information concerning issuers confidentially until issuers have approved its release. The aim of preserving the confidentiality of non-public information can be achieved by requiring CRAs to implement organisational measures to prevent the unintended, selective or improper use and disclosure of confidential information. This means, in particular, that it is imperative to include the issuer in all processes that involve a CRA forwarding to third parties, or disclosing, potentially confidential information. CRAs should be required to disclose how they ensure the confidentiality of non-public information. 4. Are there any other issues concerning access to inside information which CESR should consider from the perspective of establishing a level playing field between CRAs? No.

14 Are there any other issues concerning the Market Abuse Directive's provisions concerning inside information that you consider to be of relevance to CRAs and their activities which need to be considered? During the rating processes solicited by issuers, credit rating agencies typically gain access to inside information from issuers. They are therefore required in our view under Article 6 (3) of the Market Abuse Directive to keep a list of the persons who work for them and who have access to such information. This list has to be sent to the competent authority on request. Issuers are therefore required to enter in the list they keep only the CRA but not all the employees of the CRA with access to inside information. It is, however, unclear what the procedure is if the CRA is based outside the European Union and is consequently not subject to the requirements of the Market Abuse Directive. It should be examined here which measures may be taken to ensure that European regulators can obtain the information they need to enable them to do their job. On no account should such a situation mean that European issuers are prevented from giving inside information to CRAs outside Europe as well for rating purposes or that issuers are required to include the staff of such CRAs in their own insider list. 6. Do you consider that it would be helpful to have a dedicated regime governing CRAs and their access to inside information? In our view, a minimum standard governing the way credit rating agencies handle confidential information from issuers (not only inside information) is necessary. The IOSCO Code contains a suitable approach in this respect (see section 3. B. "The Treatment of Confidential Information"). 7. Is this provision sufficient to ensure that issuers have an opportunity to discuss and understand the underlying basis for any rating decision? If not, what other measures do you consider should be introduced? 8. In addition to being able to discuss the basis for a rating, should an issuer have a "right of appeal" where they disagree with the CRA's opinion? Before disclosure of any rating decision (new rating, updating or placement on the watch list) by a credit rating agency, the issuer affected should be advised of the key information and basic considerations underlying the decision. Such a requirement is necessary to ensure that errors are avoided, that important new information can still be included in the rating result and that the rating therefore accurately reflects the current situation. This, however, presupposes that after the rating result has been communicated to the issuer by the CRA, the issuer can appeal against the result within a reasonable period (e.g. at least five days) by submitting concrete reasons (particularly reference to the use of incorrect or incomplete data or other inapplicable facts, serious methodological errors) and demand a review of the result by the CRA before it is published. Such

15 a right of appeal should explicitly cover objective errors and misjudgements. On no account should ratings be the result of negotiations. This prevents situations where investors and the public are confronted with ratings that paint a wrong picture of the issuer s credit standing. It is an approach that directly benefits issuers and investors and, last but not least, CRAs as well, and generally makes financial markets more efficient. Ultimately, CRAs make the final decision on ratings. Although, compared with the current situation, this involves in many cases a limited extension of the period between the decision made by a rating committee and disclosure of the rating result, it does not weaken the position of investors. Investors are interested, above all, in sound rating results. It also means that subsequent corrections of ratings are largely avoided, which strengthens investor confidence in rating results and thus also the reputation of CRAs. 9. Do you consider the provisions of the current draft IOSCO Code and the Market Abuse Directive to be sufficient to ensure that information published by CRAs is accurate? We believe that the provisions of the IOSCO Code and the Market Abuse Directive are sufficient to ensure that the information published by credit rating agencies is accurate. 10. Given the lack of specificity in the current draft IOSCO Code to maintain internal records for any particular time period, do you think more specific measures would be appropriate, requiring for example all the information received by a CRA to be kept, along with records supporting its credit opinions, for a minimum of 5 years? We are in favour of specific regulation requiring credit rating agencies to keep a record of their rating processes and the data supporting their credit opinions. 11. Do you consider that it would be appropriate to introduce measures requiring the establishment of a rating agency data room to ensure that all CRAs had access to the same information concerning a particular issuer? There is no need in our opinion for measures to establish a rating agency data room if the data room consists solely of publicly available information, nor do we believe that competition between credit rating agencies could be improved to any significant extent in this way. We are against the inclusion of confidential inside information in such a data room, as such information is always forwarded bilaterally and should not be made available to third parties.

16 E. Comments on Regulatory Options concerning Registration and Rules of Conduct for Credit Rating Agencies 1. Could you assess the policy options concerning the need for regulation or other measures, with particular reference to the practical implications for competition in the rating market and for the quality of ratings and of information to the market? In particular: - A full registration/regulation regime based upon detailed criteria; - A lighter registration/regulation regime essentially based upon the IOSCO Code; - To assess compliance to IOSCO Code Fundamentals in a parallel process to CRD s recognition; - A third party s certification or enforcement of the IOSCO Code; - Relying upon rules covering only specific aspects of CRAs activity; - Monitoring the market developments. We believe that all the options set out by CESR are basically worth discussing. Moreover, we understand these proposals to mean that a combination of different options is also possible. When deciding which option to choose, the benchmark should be how the actual target, i.e. improving and maintaining the efficiency of the financial markets, can be best achieved. We do not believe that the establishment of a comprehensive regulatory system for credit rating agencies containing detailed provisions is the best way to achieve the said target. A comprehensive system of regulation and supervision solely within the EU harbours the danger that the ratings of European companies, on the one hand, and the ratings of companies from other countries on whose markets different rules apply, on the other hand, will be viewed differently by investors. The IOSCO Code of Conduct Fundamentals is an internationally agreed set of rules that has been broadly accepted by market participants. The goals pursued by the Code, i.e. improving investor protection, fairness, efficiency and transparency in securities markets and reducing systemic risk, can, however, only be achieved if the code is also applied widely in day-to-day practice. The German banking industry is therefore strongly interested in full implementation of the IOSCO Code, taking into account at the same time the aspects addressed in the above replies to CESR s questions. IOSCO believes that its code should be implemented on a self-regulatory basis but does not rule out further measures if this approach fails to work. CESR should basically follow suit and not introduce any detailed measures at regulatory level, at least at the present time. Significant deviations from the provisions of the IOSCO Code unless they are endorsed by the major international regulators or basic differences in implementation of the code should also be avoided to secure the benefits of an internationally agreed set of rules.

17 Could you please indicate your preferred option and highlight pros and cons that you see with regard to each policy option? The German banking industry believes that it would be appropriate to opt, for the time being at any rate, for market mechanisms under certain circumstances. We are in favour of an approach largely along the lines of option 5. Our reasons are as follows. In the current discussion, the large credit rating agencies have always stressed that they are prepared to submit to internationally agreed rules of conduct and organisational requirements, referring in this connection to the interest they themselves have in maintaining and strengthening their reputation. At the same time, this interest has not in the past prevented the undesirable developments that have led to the current discussion about the establishment of special rules of conduct for CRAs. Yet, given that market participants, authorities and the political sector keep a much closer watch on the conduct of CRAs today, there is more incentive for CRAs to adopt the provisions of the code and to behave accordingly. This would avoid the problems posed by broad public control to which CESR has drawn attention. We are well aware that a system of purely market-driven enforcement of certain rules of conduct and organisational arrangements which, moreover, affect institutions, whose activities have a significant influence on the fate of entire economies, is an exception. Nevertheless, it appears appropriate for the time being, provided the following conditions are met: Issuers, investors and the general public must know which credit rating agencies fully incorporate the provisions of the IOSCO code into their internal rules of conduct and organisational arrangements and which do not. This is why in line with the IOSCO Code CRAs should be required to state officially whether they have adopted the provisions of the IOSCO in full and to explain how they intend to implement these internally or to explain why they have failed to adopt certain rules ( comply or explain ). The provisions of the IOSCO Code should also be applied by credit rating agencies in their day-to-day business. This means, in particular, taking its provisions into account in their contractual practice as well. While CRAs should not be held liable for the correctness of their rating results, they must be made responsible for compliance with basic rules of procedure. It would not be acceptable if their internal code of conduct or individual rating contracts allowed them to decline all responsibility for breaches of elementary rules of conduct (such as, for example, respecting the principle of confidentiality). On the basis of regular reports from its members and IOSCO, CESR should monitor progress at reasonable intervals with the aid of market participants to determine whether the goals pursued by the code have actually been achieved and how improvements can, if necessary, be

18 achieved. These improvements may concern both the individual provisions of the code and the question of implementation and enforcement. The German banking industry wishes to make quite clear that the market-driven enforcement approach in the IOSCO Code is based on the expectation that, regardless of any regulatory intervention or the establishment of arbitration panels, credit rating agencies will take due account of the interests of issuers and investors as set out in the Code of Conduct Fundamentals and will act in awareness of the great responsibility they have for the functioning and the efficiency of the financial markets. 3. Do you think the IOSCO Code of Conduct is conducive to reducing or increasing competition? In our opinion, the IOSCO Code will improve the efficiency of the financial markets by providing for more transparency, maintaining quality levels and preventing conflicts of interest. This is where its importance lies. It will, however, have more of a limited impact on the level of competition in the rating market, as the specific market structure is largely determined by investors expectations with regard to credit rating agencies track record, which creates high barriers to market entry. 4. Are there any areas where any European rules of conduct should be extended beyond the IOSCO Code? We do not know of any other areas at present where European rules of conduct should be extended beyond the IOSCO Code. 5. To what extent is a joint treatment of rating agencies by banking and securities regulators desirable? Banks can use external ratings, i.e. ratings issued by credit rating agencies, within the framework of the new regulatory capital standards. To allow banks to use these ratings, CRAs must meet various requirements, e.g. objectivity, transparency and disclosure of their rating methodologies, and independence. National regulators decide whether these requirements have been fulfilled. The said requirements are dealt with adequately in the IOSCO Code. If, therefore, requirements for credit rating agencies such as those set in the IOSCO Code are met by these, regulatory recognition of CRAs should be possible. This would allow a joint treatment of CRAs by banking and securities regulators. Such an approach would not only be desirable but also seems obvious, as it would help to avoid duplication of work by regulators and keep bureaucracy for CRAs to a minimum.