UPDATE 1-EU watchdog tells ratings agencies to make changes

Thu Mar 22, 2012 1:46pm EDT

* ESMA says better record keeping needed

* Watchdog will follow up on report in first half 2012

* Agencies say working to improve compliance with EU rules

By Huw Jones

LONDON, March 22 (Reuters) - The "Big Three" credit rating agencies must improve their explanations of downgrades, the sector's European Union regulator said in a report on Thursday, noting other shortcomings.

The European Securities and Markets Authority (ESMA), which became the main supervisor for ratings agencies in the EU last year, examined Standard & Poor's, Moody's and Fitch in December.

The rating agencies were blamed by policymakers for helping to sow the seeds of the financial crisis by giving high ratings to mortgage-backed securities linked to U.S. home loans that defaulted.

In Europe they have also been under the gun for downgrading the debt of Greece while it's bailout package was being negotiated, a step which was viewed as making the rescue harder.

ESMA focused on ratings of banks, government bonds and covered bonds for the 12 months to 31 Oct. 2011.

There were instances where the outcome of voting on a rating change in the agency's rating committee and the reasons for making a change were not appropriately or systematically recorded, ESMA said.

"This raises concerns for the adequate recording of the main elements of the committee's analytical discussions underlying each rating action," ESMA said.

Proper records are needed to show the agency made a rating change based on "thorough analysis". Agencies also need to improve the way they show users how they arrive at a rating.

There was relief among the agencies that no major breach of rules were found or enforcement action initiated so far.

"ESMA has not determined whether any of the observations in the report constitute a breach of the Credit Rating Agency Regulation," ESMA said in a statement, adding that it will follow up on its report in the first half of 2012.

It said the report was published "without prejudice to the possibility of further investigations which could lead to enforcement or supervisory actions."

Fitch said it was pleased that its own efforts to strengthen internal processes have been recognised but it also understood the need for continuous improvement.

"Fitch is fully committed to compliance and confident that we will meet the requirements outlined by ESMA today," Fitch said in a statement.

Moody's said that in recent years it has implemented a wide range of measures to strengthen the analytical quality, transparency and independence of its ratings.

A spokesman for S&P said: "We are committed to continuously strengthening the quality and transparency of our ratings consistent with ESMA's observations and recommendations."

The EU is now approving its third set of rules in as many years for rating agencies. The latest draft law includes a requirement for users to switch to another agency after a certain number of years to boost competition.

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