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The shortcomings of sovereign ratings triggered the intervention of regulators at the EU level and in the US in order to address the gaps in existing legislation. In particular, the enacted provisions attempt to enhance transparency in the preparation of sovereign ratings, strengthen the review of those ratings and increase the quality of information used to assess the creditworthiness of States.380

In this regard, the regulatory reforms intend to replace the CRAs’ ad hoc

ratings by marking credit according to bond yield spreads, rather than the converse.381 In so far as over-reliance on credit ratings is the main target of criticisms, financial institutions and States should develop their own credit risk assessment in order to reduce the mechanistic influence of CRAs.382

At EU level, Regulation No 462/2013383 introduced significant obligations for sovereign ratings in order to address the huge role they came to play during the Euro debt crisis. According to recital 45 in the preamble to the 2013 CRA Regulation, ‘when publishing their sovereign ratings, credit rating agencies should explain in their press releases or reports the key elements underlying those credit

379 _{Marek Hanusch and Paul M. Vaaler, ‘Credit Rating Agencies in Emerging Democracies.} Guardians of Fiscal Discipline? (2013) The World Bank, Policy Research Working Paper No 6379, 8, where the authors argue that ‘CRAs play a positive role in emerging democracies around the world as private guardians of public fiscal discipline’.

380 _{It is generally considered that rating announcements often provide information that the market} has already taken into account, causing alarm among market participants and exacerbating reliance on credit ratings.

381 _{Bartholomew Paudyn, ‘Credit rating agencies and the sovereign debt crisis: Performing the} politics of creditworthiness through risk and uncertainty’ (2013) 20 Review of International Political Economy 4, 793-794.

382 _{Gillian Tett, ‘Beware the consequences of reassessing sovereign risk’ Financial Times (London} 4 November 2011).

ratings’ and, most importantly, ‘credit rating agencies should refrain from any direct or explicit policy recommendations on policies of sovereign entities’.

Although these provisions aim to reduce the risk of inaccurate assessments by imposing certain restrictions, CRAs are not forced to verify the correctness of their data and the appropriateness of their announcements.384 As a result, the demand for sovereign credit ratings (in particular, foreign currency ratings) remains prevalent and relevant in the international bond markets.385

Article 8a(2) of the 2013 CRA Regulation improves the quality of ratings of sovereign debt of EU Member States by providing that CRAs cannot issue any rating outlooks ‘without the consent of the rated entity, unless [the relevant information] is available from generally accessible sources’.386 Also, Article 8a(3) of the 2013 CRA Regulation requires CRAs to set a calendar indicating when they will rate Member States, limited to three dates per year for unsolicited sovereign ratings.387

This rule focuses on transparency by providing that sovereign ratings should take into consideration the individual country reports and be made publicly available. In addition, the above rule states that potential changes in sovereign outlook should not be based on information provided by the rated entity without its consent and the publication of those ratings should take place only at the end of business of the trading venues and at least one hour before their opening.

At first glance, this rule is designed to mitigate the risk of volatility of government debt that may harm the financial stability of the Eurozone and the economic policies of Member States in distress. However, the EU legislator

384 _{On 18 July 2014, ESMA published ‘Technical advice to the European Commission on the} development of an EU creditworthiness assessment for sovereign debt’. In this report, ESMA underlined the need to ensure that (1) the rating process should be fully independent; (2) the review function responsible for the annual review of rating methodologies must be independent of the business lines which are responsible for credit rating agencies; (3) the access to pre-rating information should only be available to people involved in rating activities and all necessary steps should be taken to ensure this information is adequately protected; and (4) the sufficient resources should be available for the conduct of both a rigorous rating process as well as ongoing monitoring.

385 _{The activities of CRAs with regard to sovereign credit risk assessments have been strongly} questioned for their bad timing and for the fact that they lagged behind markets in their judgement. This means that CRAs provide a measure of risk rather than prognosis of the probability of default. See on this view Nicolas Véron and Guntram B. Wolff, ‘Rating Agencies and Sovereign Credit Risk Assessment’ in European Parliament, Directorate General for Internal Policies, Rating Agencies - Role and Influence of their Sovereign Credit Risk Assessment in the Euro Area, Monetary Dialogue December 2011, December 2011, 64.

386 _{Article 8a(2) of Regulation (EU) No 462/2013.} 387 _{Article 8a(3) of Regulation (EU) No 462/2013.}

missed the opportunity to reduce the powerful influence of CRAs by banning unsolicited sovereign ratings for EU Member States. It seems that the legislator adopted a ‘light touch approach’ instead of enacting strict rules to act as a constraint on rating agencies’ watch statements. The EU Regulation does not address the possibility of holding CRAs accountable for the consequences of their outlooks on sovereign bonds.388

ESMA issued a report in which rating agencies were accused of exacerbating the sovereign debt crisis by publishing debt-rating downgrades of periphery and core EU States.389 In particular, ESMA revealed shortcomings in CRAs’ controls and resources and found deficiencies in the way that they manage the highly market-sensitive task of assigning ratings to government debt.390 The ESMA report can be considered a first attempt to restore the transparency of sovereign assessments and to address the weaknesses in the sovereign ratings process.

Admittedly, the assessment of likelihood of government default is a challenging task for CRAs basically because sovereign debt contracts cannot be enforced by a third party and it is complicated to predict the willingness to pay in sovereign borrowing.391

In point of fact, the sovereign entity cannot be dissolved, a forced liquidation of its assets is impossible, and its creditors cannot assume ownership.392 This implies that the instruments to deal with sovereign-debt crises in an orderly way are limited. In the case of private debt, the ultimate solution remains liquidating the borrower’s assets and, in the case of corporations, dissolving the organisation. In the case of sovereign debt, a procedure should be found to restructure the debt

388 _{For an academic commentary see Anil K Kashyapy and Natalia Kovrijnykh, ‘Who Should Pay}

for Credit Ratings and How?’ (2013) National Bureau of Economic Research Working Paper No 18923.

389 _{ESMA, ‘Credit Rating Agencies. Sovereign Ratings Investigation’, 2 December 2013, 3.}

390 _{Sam Fleming, ‘Rating agencies face fines threat after EU sovereign debt probe’ Financial}

Times (London, 2 December 2013).

391 _{Rawi Abdelal, Capital Rules. The Construction of Global Finance (Cambridge MA: Harvard} University Press 2007) 162-163.

392 _{Lee C. Buchheit and G. Mitu Gulati, ‘Responsible Sovereign Lending and Borrowing’,} UNCTAD Discussion Papers No 198, April 2010, 1. The authors argue that ‘the word sovereign connotes an entity that is not subject to external constraints, least of all the tiresome constraint of repaying borrowed money. Yet sovereigns borrow money all of the time and they pay it back most of the time’.

in an orderly fashion through negotiations with the creditors given that it is impossible to liquidate the debtor.393

In the US, the Dodd-Frank Act recognizes the systemic importance of credit ratings and the reliance placed on CRAs activities as matters of national public interest.394 In particular, the Dodd-Frank Act imposes new rules with respect to CRAs’ public disclosure and, generally, to over-reliance on the credit ratings industry (by removing statutory references to credit ratings).395

Section 931(5) of the Dodd-Frank Act states that the inaccuracy of credit ratings on the structured finance market ‘contributed significantly to the mismanagement of risks by financial institutions and investors, which in turn adversely impacted the health of the economy in the United States’.396

Closer examination of the text suggests that, on the one hand, the Act does not provide any specific provisions on the regulation of sovereign ratings. On the other hand, it leaves the function of monitoring these ratings completely to the SEC. However, a more explicit reference to the accountability of sovereign ratings and to the disclosure of their methodologies’ criteria would have been desirable.

It seems clear that the reforms implemented in the US securities markets do not attach great importance to the CRAs’ government credit risk assessment owing to the fact that the latter had less impact on US public debt during the 2007-2009 financial crisis.397

393 _{Sovereign debt remains difficult to enforce because creditors’ ability to collect is limited by the} fact that only assets located outside the sovereigns’ borders can be legally attached and countries tend to hold most of their assets within their borders. These elements imply that the instruments to deal with sovereign-debt crises in an orderly way are more limited than in the case of private debt, where the ultimate solution remains liquidating the borrower’s assets and, in the case of corporations, dissolving the organisation. See Rodrigo Olivares-Caminal, ‘Statutory Sovereign

Debt Resolution Mechanisms’ in Rosa M. Lastra and Lee Bucheit (eds), Sovereign Debt

Management (Oxford: OUP 2014) 333-335; Rodrigo Olivares-Caminal, ‘Litigation Aspects of Sovereign Debt’ in Rodrigo Olivares-Caminal, John Douglas, Randall Guynn, Alan Kornberg, Sarah Paterson, Dalvinder Singh and Hilary Stonefrost (eds), Debt Restructuring (Oxford: OUP 2011) 389-391.

394 _{Section 931(1), Title IX, Subtitle C of the Dodd-Frank Act “Improvements to the Regulation of} Credit Rating Agencies”.

395 _{Section 939, Title IX, Subtitle C of the Dodd-Frank Act “Removal of statutory references to} credit ratings”.

396 _{Section 931(4) of the Dodd-Frank Act states that ‘in certain activities, particularly in advising} arrangers of structured financial products on potential ratings of such products, credit rating agencies face conflicts of interest that need to be carefully monitored and that therefore should be addressed explicitly in legislation in order to give clearer authority to the Securities and Exchange Commission’.

With these considerations in mind, it possible to argue that sovereign ratings play a useful role in fostering the stability and efficiency of the worldwide sovereign debt market. However, their use may have a dangerous influence on fragile economic policies—exacerbating the risk of volatility and facilitating the ‘alarm effect’—that may turn into speculative attacks on the securities markets.398 After considering the regulatory reforms on sovereign ratings activities introduced in the EU and US legislation and the main steps adopted for implementing the quality, independence, and transparency of the sovereign ratings process, the next section investigates the phenomenon of over-reliance on ratings and ventures proposals to make CRAs responsible for misrepresentation or detrimental reliance.