About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline

12 J. Banking Reg. 1 (2010-2011)

handle is hein.journals/jlbkrg12 and id is 1 raw text is: Original Article
Regulating credit rating agencies:
The issue of conflicts of interest in
the rating of structured finance products
Tobias Johansson
got his first law degree from the School of Business, Economics and Law, University of Gothenburg, and
holds a LLM in Banking and Finance Law from Queen Mary, University of London. He is an associate at
Setterwalls law firm, Sweden, and a member of the firm's Banking and Finance team. The opinions expressed
in this article do not necessarily represent the position of Setterwalls Law Firm.
Correspondence: Tobias Johansson, Setterwalls Law Firm, Sankt Eriksgatan 5, 404 25 Gothenburg, Sweden
E-mail: tobias.johansson @setterwalls.se
ABSTRACT As a result of the financial crisis, the work of the credit rating agencies (CRAs) has been
questioned. It is said that they underestimated the risk in structured finance products and allowed conflicts of
interest (for example, the issuer-pays model) to affect their ratings. Consequently, the regulatory frameworks have
been reviewed. This article reflects upon the ongoing debate and suggests that the issue of conflicts of interest
should be approached in a complete and coherent manner; in addition to regulating CRAs, other contributing
factors need to be addressed. As a result, three different proposals are put forward. First, it is argued that
regulation of CRAs is necessary, but with more global convergence and less detailed provisions than under
current regimes. Accordingly, the introduction of a global, principles-based rulebook is advocated. Second, it is
suggested that CRAs should be held civilly liable for malfeasance to the same standards of negligence as those
applying to other institutions, which is not the case today because of a 'privileged' regulatory treatment. Finally, a
case is made for less reliance on ratings since that would increase market heterogeneity, thereby contributing to
a more resilient financial system that is less susceptible to the potential effects of conflicts of interest in CRAs.
Journal of Banking Regulation (2010) 12, 1-23. doi:10.1057/jbr.2010.3
Keywords: regulation credit rating agencies; rating-based regulation; civil liability credit rating agencies

INTRODUCTION
Background
In 2005, after a couple of years of increased
use, structured finance products represented 43
per cent of the global amount of debt instruments
in issue in the capital markets.1 Up until the
summer of 2007, the market continued to
prosper, driven by the products' multiple ad-
vantages: off-balance sheet treatment, lower cost
for regulatory capital, customised investments and
a spread of risks, which according to the IMF,
'helped to make the banking and overall financial
system more resilient'.2

Credit rating agencies (CRAs) were an
essential part of this development; the products'
complexity required professional risk assess-
ments. Structured finance products were con-
sidered 'safe', and in January 2008 there were
64 000 structured finance products rated triple
A. At the same time, only 12 companies in the
world were rated triple A.3
We now know that the world can change in
2 years. The perceived stability has been
replaced by credit crunch, market turmoil and
a world in recession. Structured finance is
'dead' and rating agencies are among those
facing criticism for their underestimation of the

© 2010 Macmillan Publishers Ltd. 1745-6452 Journal of Banking Regulation Vol. 12, 1, 1-23
www.palgrave-journals.com/jbr/

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Short-term subscription options include 24 hours, 48 hours, or 1 week to HeinOnline.

Contact us for annual subscription options:

Already a HeinOnline Subscriber?

profiles profiles most