Eliminating Regulatory Reliance on Credit Ratings: Restoring the Strength of Reputational Concerns

59 Pages Posted: 31 Jul 2012 Last revised: 14 Aug 2015

See all articles by Bianca Mostacatto

Bianca Mostacatto

Max Planck Institute for Tax Law and Public Finance

Date Written: July 31, 2012

Abstract

Credit ratings agencies play an important role in the world-wide capital markets and, willingly or not, influence rather significantly the destinies of private and public financial players and their issues. Credit rating agencies invoke reputation as their most valuable asset and as guarantee for their independence and honesty in the intermediation of financial information. Yet the accuracy and honesty of credit ratings have been, nonetheless, questioned at numerous times, and the lack thereof was pointed as one of the causes of recent crises affecting the global financial system.

Using legal and economic analysis, this article demonstrates how reputation works in the credit rating business to encourage rating accuracy and how governmental actions – mainly by the massive use of ratings in laws and regulations – were responsible for rendering the reputational mechanism ineffective. Considering the factors which influence the trade-off faced by rating agencies, the movements towards regulation and oversight of these entities in the U.S. and in the EU are comparatively analyzed. The paper concludes that restoring the strength of the reputation mechanism, notably by eliminating regulatory reliance on ratings and rating safe-harbors, is the only effective measure to ensure rating accuracy – as well as the only measure really consistent with the public goals of increasing competition in the informational business, fostering innovation and better risk management by investors, improving accountability in capital markets and ensuring that investors are encouraged to rely on ratings only when ratings are deemed reliable. It then argues that, even though regulation and oversight of rating agencies might have been unavoidable at this point in time, deregulation of the rating business, once regulatory reliance is eliminated, is also indispensable to secure the aforementioned goals.

Keywords: financial markets regulation, credit rating agencies, reputation, governmental intervention, law and economics

JEL Classification: D79, G18, G24, G28, K22, K23, L51

Suggested Citation

Mostacatto, Bianca, Eliminating Regulatory Reliance on Credit Ratings: Restoring the Strength of Reputational Concerns (July 31, 2012). Published in Stanford Law & Policy Review, Vol. 24, No. 1, 2013, Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2012-07 , Available at SSRN: https://ssrn.com/abstract=2120395 or http://dx.doi.org/10.2139/ssrn.2120395

Bianca Mostacatto (Contact Author)

Max Planck Institute for Tax Law and Public Finance ( email )

Marstallplatz 1
Munich, 80539
Germany

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