Developments in the role and regulation of credit rating agencies
The global financial crisis has brought about a shift in the regulation of credit rating agencies. In a step towards conforming with international efforts to regulate these bodies, South African legislators are seeking to introduce new law in the form of the current Credit Ratings Services Bill (published under Gazette No. 35022 of 7 February 2012) (the “Bill”). Following a number of parliamentary deliberations since its introduction earlier this year, we expect to see further developments under the Bill in the near future.
- The need for regulation is evident from, amongst other things, the wide criticism that rating agencies have received for their role in the financial crisis.
- The departure from a ratings-based regime has manifested in the recent removal of key credit ratings requirements from the revised prudential investment requirements applicable to collective investment schemes and pension funds.
- The Bill aims to increase accountability and transparency, create key statutory duties for agencies and impose a code of conduct (based on an international code prescribed by the registrar of credit rating agencies (the “Registrar”)). The Bill also requires that agencies register with the Financial Services Board (the “FSB”) and comply with certain reporting requirements.
- Key features of the Bill and some of the latest developments include the following:
- The Bill is limited in its scope in that it applies to credit rating services performed or credit ratings published in South Africa, as well as persons performing such services or publishing such ratings. The Bill is not intended to apply to what is described as “private credit ratings” which are not intended for “public disclosure or distribution” (see section 3(4) of the Bill). Notwithstanding this, the Bill requires that credit rating agencies disclose a number of details to the Registrar, including their 20 largest clients and the percentage of revenue that each of those 20 clients contribute to the total revenue of the agency (which disclosures do not expressly exclude clients that obtain private ratings).
- The Bill will see credit rating agencies being bound by a number of statutory duties, including the implementation of administrative, accounting and risk management procedures and the establishment of internal units for the purposes of communicating with investors and the public. Credit rating agencies will also be obliged to use rigorous and systematic rating methodologies that are subject to review on a regular basis.
- One of the most controversial aspects of the Bill is whether or not it seeks to extend the common law liability of credit rating agencies. The Bill currently provides for delictual liability of credit rating agencies in favour of investors or members of the public in respect of loss suffered as a result of a credit rating or credit rating services (see section 19). This section has been interpreted by some to establish a statutory duty of care or create a new form of quasi-statutory, quasi-delictual liability and has also raised a number of other issues regarding the potential expansion of the common law framework, such as the overlap between contractual and delictual remedies, exclusions of liability, the requirement for mandatory insurance cover and Registrar intervention).
- The Committee have also reached consensus on the deletion of section 19(3) of the Bill, which prohibits a credit rating agency from contracting out of liability under section 19. The deletion was made on the basis that the application of the common law is inherent and that the Committee thought it better left to the courts to decide whether such a contractual provision would be valid or not.
- Another noteworthy feature of the Bill is the endorsement by locally registered credit rating agencies, of credit ratings issued by foreign credit rating agencies, where credit rating services in respect of such ratings have been undertaken partly or entirely by the local agency or an external agency in the same group as a local agency and where the issuer of the rating has been approved by the Registrar (see section 18(1)). Whilst it has been suggested that this requirement would place legal and administrative burdens on agencies and the FSB, the National Treasury have expressed the view that the provision should be read to require that the Registrar approves each foreign agency which is an issuer of the relevant rating, as opposed to approval of each particular endorsement.
- The Bill contemplates heavy penalties for contravention, including criminal liability and up to 10 years in prison for offences such as deliberate misstatements or concealment of material facts, or the issue of a rating without registration. Despite recent deliberation by the Committee on the offences and penalties provisions of the Bill, no amendments have been proposed by the Committee.
As we continue to advise clients on these matters, we will be monitoring the progress of the Bill closely.
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