Post-Brexit Credit Rating Agency Regulation Decided: The Correct Call?

In 2017, this author produced an article that examined the potential regulatory framework that exists in the UK where Credit Rating Agencies are concerned (later published in 2018). We spoke about this issue here in Financial Regulation Matters, where we discussed how there may be a need to incorporate sole regulatory responsibility within one of the regulatory bodies should the UK be unable to come to a ‘deal’ with their EU partners. As part of the EU (Withdrawal) Act, the Government has recently come to a decision regarding which body would be responsible for regulating the CRAs in the wake of a no-deal Brexit, and it confirms the findings of the article. However, it is worth revisiting this developing story to examine what the consequences of such a decision may be.

It has been decided, as the original article produced by this author predicted, that the Financial Conduct Authority would be the regulatory body charged with supervising the credit rating industry, should the UK be unable to negotiate a post-Brexit deal with the EU. In a very short document, the FCA state that a draft Statutory Instrument will transfer the regulatory responsibility to the FCA from the ESMA, and change the FCA’s role from ‘competent authority’ to that of principal regulator. Also, there is no details made available regarding the fees the CRAs would be charged, and the proposed timeline advanced by the FCA describes how a consultation of applicable technical standards for CRAs will be made available from the 9^th of October , and that the application window for CRAs wishing to transfer their registration status to the FCA will open from ‘early 2019’. In the FCA’s ‘Business Plan’, they do discuss how the resources required for ‘onshoring’ the CRAs will be derived from the CRAs themselves via levies and fees, with the suggestion being that the required level of resources may be around £6m.

As we discussed in the associated post from 2017, the FCA was always going to be the likely regulator selected for this task. The fear from the business media was that there would be the need for a ‘cobbled-together’ regulatory framework to govern the rating agencies, but in reality the CRAs are accommodated much easier within the FCA than any other regulator, and offer a much cheaper alternative than creating a new regulator. The FCA was the regulator of choice for the CRAs themselves, who were rightly worried that to go unregulated would cause massive problems for their business, and their users. The FT also suggested that there may be an issue of regulatory imbalance between the FCA and the ESMA from the perspective of the EU, but with the FCA acting as a competent authority since its inception in this realm, this is unlikely to be the case in reality. However, the real issue is not whether the process is smooth or not, but whether the FCA is the right regulator for the job.

In truth, the FCA is the best placed regulator amongst the British regulatory framework for the job. Yet, this does not mean that it will be successful in doing so. Rather, it is feared that the FCA will struggle with what is a massive task in regulating such an industry. We have covered the FCA so many times here in Financial Regulation Matters it is difficult to select an appropriate link to a post, but this post that examines whether the FCA is ‘soft’, or has its hands tied, is a snapshot of the problems surrounding the FCA. Its performance this year has not been good at all, and its performance regarding RBS and the GRG Unit specifically leaves a particularly sour taste in the mouth. In terms of Gatekeepers, the FRC is tasked with regulating the audit industry (and is not doing a great job, as evidenced by persistent transgressions by those firms), and now the FCA may have to regulate another Gatekeeper. The fear is that a lax regulatory approach is the last thing required when regulating the credit rating agencies, because they have the capacity to transgress and cause serious damage, as evidenced by the Big Two’s recent and record fines. Does the FCA have the authority to properly regulate an oligopolistic powerhouse like the credit rating industry? It seemingly does not have the authority to properly regulate the banking industry, so by deduction it is difficult to see how it may properly regulate the Credit Rating industry. One aspect that does not aid in this vision of the FCA having regulatory authority is its extraordinarily limited range of penalising options, which would need to be addressed if it were tasked with regulating the rating industry – fines of a few hundred thousand pounds will not suffice with this industry.

Yet, there is scope for development. The FCA could learn from the experiences within the US, where the SEC were tasked with developing an ‘Office for Credit Ratings’ but performed woefully in doing so (it was not even staffed for 12 months). In attempting to learn such lessons, the development of a dedicated office, or ‘spearhead’ for the FCA would be positive, and allow the FCA to accelerate its understanding of this tremendously complex relationship that exists elsewhere between CRAs and regulators – the FCA have no experience in this regard. Whilst the risk of ‘capture’ is increased with the creation of a dedicated ‘office’, in reality that risk is probably no greater than the general risk of ‘capture’ between a highly specialised and oligopolistic sector and its regulator.

Ultimately, the FCA is the right regulator to be selected from the framework, but this does not mean that it is the right regulator. In the event of a no-deal Brexit, there would need to be organisational changes within the FCA to cope with this new burden. Any political or regulatory belief that one can simply just transfer the registration from the EU and continue to regulate effectively is massively misplaced, and will be taken advantage of – such oligopolistic sectors thrive on such regulatory arbitrage, and the post-Brexit environment is both primed for such arbitrage, but also incredibly vulnerable to the effects of regulatory arbitrage. British society has been consistently placed under severe pressure since the Crisis, and a period of upheaval borne from financial actors taking advantage of gaps in the marketplace could be massively detrimental.

Keywords – FCA, Credit Rating Agencies, Business, Politics, UK, EU, Brexit, @finregmatters