* Dagong Europe under scrutiny by EU regulators-documents
* ESMA probe identified compliance, audit failings-documents
* ESMA has power to fine, revoke rating agency licences
HONG KONG, Dec 23 (Reuters) - European regulators identified weaknesses in the internal system of checks and balances at Chinese-owned credit rating agency Dagong Europe during a two-year probe, according to documents reviewed by Reuters and people familiar with the situation.
The probe is a potential blow to China’s biggest rating agency Dagong Global, which set up Dagong Europe in Italy in March 2012 as the first Asian challenger in Europe to the big three U.S. agencies - Moody’s, Fitch and Standard and Poor’s.
The confidential investigation is being carried out by the European Securities and Markets Authority (ESMA), which has the power to approve, supervise and sanction rating agencies inside the EU.
At issue is the regulator’s concerns that Dagong Global may not be fully compliant with strict EU rules designed, among other things, to prevent conflicts of interest in rating the creditworthiness of clients.
Compliance with such rules is a condition of the licence it was granted in June 2013 to operate across the 28-nation bloc.
ESMA has the power to censure, fine and even withdraw an EU licence if it finds that a rating agency has infringed Europe’s Credit Rating Agency regulation, according to its website.
Contacted by Reuters, ESMA said it does not comment on ongoing supervisory activities. Dagong Europe declined to comment.
The clash with EU authorities, yet to be resolved, has absorbed much of Dagong Europe’s energy, people with direct knowledge of the rating agency said.
The rating agency, which has just a 0.02 percent market share in Europe according to ESMA data, has yet to turn a profit.
The probe was triggered by a complaint from Mandarin Capital Partners, a private equity firm that had initially backed Dagong Europe, concerning potential violations of Dagong’s EU licence, according to people familiar with the matter.
Mandarin Capital, which sold its stake in Dagong Europe at the end of 2014, declined to comment.
EMSA asked Dagong Europe, among other things, to set up so-called Chinese walls within the company to ensure “the persons validating the (rating) methodology do not vote in rating committees”, according to one August 2014 letter to the agency seen by Reuters.
ESMA also criticised the role of one of the Dagong’s two independent board members, who it said had not provided any opinion or proposals for more than a year.
“Wei Benhua may not have appropriately performed his role as independent non-executive director as required by the Credit Rating Agency Regulation, since he had limited interaction with the internal control functions,” ESMA said in August 2014.
Attempts to contact Wei, a former senior Chinese central bank officer, by phone and email on Tuesday and Wednesday were unsuccessful.
Dagong proposed remedies to the weaknesses identified by ESMA, the confidential correspondence shows.
Despite attempts by Dagong to address regulatory concerns through an action plan ESMA requested in August 2014, the sources said not all compliance matters have been resolved.
The arrival of Dagong in Europe, was welcomed in European business circles as an attempt to bring more competition to the ratings business, whose dominance by the “big three” came under fire in the wake of the 2007-09 global financial crisis. (Editing by Mark Bendeich and Alex Richardson)
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