I’ve had a number of conversations with extremely bright, extremely high level professionals about credit rating agencies recently, which have all consistently highlighted the European Securities and Markets Authority’s (ESMA’s) heightened interest in credit rating agencies (CRAs) operated outside the European Union.

For over half a decade, foreign CRAs have been able to issue ratings in the EU if the ratings were “endorsed” by a European rating agency (usually an affiliate) registered with ESMA. But now, under recent ESMA proposals, foreign CRAs will have to take more steps to demonstrate their compliance with EU requirements. According to the FT, this all will have a significant impact on the UK, which is the hub for Standard & Poor’s, Moody’s, and Fitch; together, they reportedly employ about 1,400 people generating £600m of revenues.  Once the UK leaves the EU, CRAs based there would no longer qualify as EU entities; they could thus potentially have to establish a new EU outpost, and that new outpost would have to demonstrate the foreign parent’s compliance with ESMA rules relating to the operation and even governance of the firm.

But to do even this, there will have to be some kind of regulatory agency in the UK available to enforce ESMA-like standards in the UK.  Which leads to the more fundamental question: “Who will regulate CRAs in the UK after Brexit?”  At this point, oversight is, of course, practiced by ESMA (a fact that itself has an interesting political history). But presumably, there will not be any interest in formally ceding authority to ESMA since the point of Brexit, as they say, is Brexit. Candidates to replace ESMA would, I suppose, include the Financial Conduct Authority (FCA) and the Bank of England.   The latter seems extremely unlikely, especially given the conflicts of interest that would arise if the country’s sovereign ratings continue to take a hit after Brexit. The FCA is a better bet, but would involve adding to the agency a remit that would bolster an already jack-of-all trades prudential profile. A key aspect of its work would be completing the implementation of now years-old guidelines aimed at reducing market over-reliance on CRA ratings. (Good luck!)

In any event, the new UK authority would have a lot of work to do to preserve the ability of London-based CRAs to continue to provide ratings in Europe. In the absence of not just formally adopting ESMA’s standards—but also apparently demonstrating market participants’ compliance with them—the UK risks losing CRAs and jobs to multiple countries.  Indeed, with the largest CRAs based in the United States, the prospect of being locked out of Europe will energize firms with London hubs to either decamp to the EU (my guess is Paris) in order to continue to provide ratings for European customers, or to relocate at least partially to their home shores. And given the stakes, and the need to avoid nasty surprises, the decision to do either (or both) will likely be made well before the divorce terms of Brexit are ever finalized.

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