Brexit May Drive Credit Raters From U.K.’s Supervisory Limbo

  • Moody’s, S&P and Fitch are overseen directly by ESMA
  • ESMA would probably require main operations in EU, lawyer says

Banks based in the U.K. are looking at escape routes in case the country’s secession from the European Union cuts them off from the single market. For the companies that rate their debt, this threat is particularly direct.

The largest credit-rating companies -- Moody’s Investors Service, S&P Global Ratings and Fitch Ratings -- and many of their smaller competitors base their main European operations in London. They’re supervised by the European Securities and Markets Authority in Paris. And that’s the problem.

After Brexit, ESMA, the EU markets regulator, will probably lose jurisdiction over London-based companies, whose ratings would no longer be accepted for regulatory purposes in the bloc. If talks on Britain’s withdrawal from the EU begin before March 31, as Prime Minister Theresa May has promised, the two-year Brexit clock would expire in early 2019. That leaves little time for the big three to decide whether to stick or twist.

“There’s a question about how much ESMA will allow them to keep significant operations in London, essentially being fronted by an ESMA-registered office in say, France or Germany,” said Michael Sholem, a lawyer at Davis Polk & Wardwell LLP in London. “You can’t just have a nameplate in France or Germany.” 

Should exit negotiations between the EU and the U.K. break down, “very much the most likely outcome is a relatively swift move of this business to the EU,” Sholem said. “If there’s a five-, seven-year transitional period, then I can see people wouldn’t want to move immediately. If they’ll be able to carry on providing ratings to EU financial institutions, it could be a gradual process.”

Unlike banks, which have been supervised on a national level for decades, ratings companies were effectively unregulated before the crisis, then got swept up in the tide of rule-making that came after 2008. ESMA is the single supervisor of such companies in the EU.

If they have to relocate to retain their access to the EU, a lot of people could be heading across the Channel. S&P had 413 people in its U.K. office last year, generating 262 million pounds ($322 million) of revenue, according to the firm’s transparency report. Moody’s reported 430 employees in the U.K. and revenue of 250 million euros ($274 million), while Fitch had 552 staff and 99 million pounds of revenue.

The requirement for an EU base is required by regulations, according to Felix Flinterman, head of supervision at ESMA.

‘Escape Route’

“If firms want their ratings to be used for regulatory purposes in the EU, the ratings must be issued in the EU,” he said. “There’s an escape route and that’s endorsement. EU offices can endorse a rating that’s issued by an office in, say, New York, and that rating can be used for regulatory purposes in the EU.”

Endorsement acknowledges that a non-EU country has legal requirements for ratings firms that are as stringent as the bloc’s, and that it has effective supervision. Ten countries have been granted this status, including Argentina, Japan, Mexico and the U.S. The EU-registered company can only endorse ratings issued by members of the same group.

ESMA is also able to certify third-country ratings companies, allowing its grades to be used for regulatory purposes. However, this is limited to opinions regarding issuers established, or financial instruments issued, outside the bloc.

“The big three all have registered offices on the continent,” said Sholem. “It would be open to the London-based companies to move some of their operations to Europe to get around the timing and logistical problems of certification and third-country arrangements.”

For now, the ratings firms are waiting to see what path the Brexit negotiations take.

“Fitch will continue to maintain a strong and constructive dialogue with its regulators all over the world,” said spokeswoman Rebecca O’Neill. S&P will “wait to see how the supervisory landscape in the U.K. will develop,” spokesman Mark Tierney said. Moody’s is “monitoring the situation as it continues to develop,” the company said.

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