Revisiting ESMA’s 2023 CRA Market Share Report – what now in 2024 and beyond?

RegCORE Client Alert | Capital Markets Union

QuickTake

On 20 December 2023 the European Securities and Markets Authority (ESMA) published its 2023 Credit Rating Agency (CRA) Market Share Report. This 2023 edition builds upon previous principles set out in an ESMA 2017 supervisory briefing (the 2017 SB) setting out a common supervisory approach to the CRA RegulationAvailable here.Show Footnote including provisions for encouraging issuers or related third parties to use “smaller CRAs”.Available here.Show Footnote

While the CRA Market Share Report may have gone somewhat underread (however not by your EU RegCORE and advice to clients) as 2023 gave way to 2024, the aspects set out in both the ESMA 2017 SB and the 2023 CRA Market Share Report are ever more important in 2024 and beyond. This is particularly the case as the EU’s co-legislators as well as the European Supervisory Authorities (ESAs), chief among them, ESMA, push forward to (finally) complete the EU’s Capital Markets Union (CMU) project in its third meaningful iteration following announcements by ESMA on 22 May 2024 (see standalone coverage form our EU RegCORE on this development).

Given the importance of credit ratingsDefined in the CRA Regulation as “an opinion regarding the creditworthiness of an entity, a debt or financial obligation, debt security, preferred share or other financial instrument, or of an issuer of such a debt or financial obligation, debt security, preferred share or other financial instrument, issued using an established and defined ranking system of rating categories.”Show Footnote as well as CRAs to the EU’s financial and certainly capital markets, as well as the renewed efforts to finalise CMU and focus on financial market infrastructure participants and the role of Sectoral Competent Authorities (SCAs)SCAs refer to those national competent authorities (NCAs) designated under the relevant sectoral legislation for the supervision of “credit institutions, investment firms, insurance undertakings, reinsurance undertakings, institutions for occupational retirement provision, management companies, investment companies, alternative investment fund managers, central counterparties and prospectuses.”Show Footnote, this Client Alert assesses the arguments that are made by ESMA in favour of issuers using “Smaller CRAs”. With legislative policymakers pushing to revitalise CMU, CRAs and greater choice in specialisation is very much in focus. Smaller CRAs, as complementary alternatives to established CRAs, which of course continue to play an important role, have an important role to offer EU market participants. This applies to what the CRA Regulation distinguishes between “CRA Activities”Which means “…data and information analysis and the evaluation, approval, issuing and review of credit ratings.Show Footnote and “Ancillary Activities”.Which is defined as those services “…not part of credit rating activities; they comprise market forecasts, estimates of economic trends, pricing analysis and other general data analysis as well as distribution services.”Show Footnote In accordance with Article 8d(3) of the CRA Regulation, the total market share for each registered CRA is calculated with reference to annual turnover generated from CRA Activities plus Ancillary Activities at group level in the EU for that CRA or group of CRAs.

Key takeaways from the 2017 SB and the CRA Market Share Report

The aim of Article 8d of the CRA Regulation is to increase competition in the CRA industry by encouraging issuers or related third parties to appoint smaller CRAs. Article 8d of the CRA Regulation requires issuers or associated third parties to consider appointing at least one CRA with no more than 10% of the EU market share to rate an issuance or organisation. Article 8d(1) states that where issuers or related third parties intend to use two or more CRAs, they should consider appointing one CRA with less than 10% market share in the EU. The CRA Regulation (Article 8d) requires an issuer or linked third party to document their choice not to choose a CRA with less than 10% market share. 

The obligations of Article 8d are supervised and enforced at national level by the relevant SCAs. In order to assist issuers or related third parties with this assessment, Article 8d(2) of the CRA Regulation requires ESMA to publish annually a list of registered CRAs and the types of credit ratings they issue, together with a calculation of CRAs’ revenues from credit rating activities and ancillary services at group level. 

The 2017 SB noted that a “successful implementation” of Article 8d of the CRA Regulation across the EU Member States was “… has been hindered by a lack of clarity in a number of key areas, including but not limited to: [A] Which issuers or related third parties are captured by the requirements. [B] How the requirement to ‘document’ should be met.” The 2017 SB noted that these difficulties were noted in an European Commission Report on the CRA market,Available here.Show Footnote from 2016 which also explored (briefly and unsuccessfully for the time being) also creating a pan-EU CRA and instead on improving CRA’s operations (of all sizes) across the EU, and promoting “the broadest possible acceptance of smaller CRAs, including in the context of the ESCB[European System of Central Banks – which includes the ECB and national central banks]’s European Credit Assessment Framework (ECAF)”. Arguably, there is still a way to go on this point, as equally noted in  ESMA’s earlier Technical Advice on Competition, Choice and Conflicts of Interest in the CRA Industry,Available here.Show Footnote which highlights that smaller CRAs “…indicated there was a need for SCAs to promote and enforce the provisions of Articles 8c and 8d in order to fully achieve the objective of the [CRA] Regulation.” The 2017 SB thus laid a path to harmonise reporting and transmission of information. It does this by proposing use of a “Standard Form” available to those in scope of the Article 8d obligation, so as to allow SCAs to more actively monitor compliance with Article 8d’s requirements. 

The 2023 CRA Market Share Report, which is based on audited financial statements with reference to annual CRA Ratings and Ancillary Services activities from 2022, factually summarises the current state of play of CRAs (large and small) across the EU and developments since the 2017 SB and encourages the use of the Standard Form. 

Market shares are set out overall on pages 8 and 9 and by rating category in Section 9 of the CRA Market Share Report. In the case of the latter, these are based on the proportion of instruments for which an EU-issued rating has been assigned by EU registered CRAs.

ESMA’s CRA Market Share Report shows that the credit rating market in the EU remains highly concentrated, with the three largest CRAs (EU operations of non-EU headquartered providers) accounting for over 90% of the total market share in 2022. ESMA also concludes that the market shares of the smaller CRAs vary significantly by rating category, with some CRAs having a higher presence in certain segments, such as insurance, corporate non-financial, or structured finance. 

ESMA recommends that issuers and/or related third parties should consult the list of EU registered CRAs and their market shares, as well as the types of credit ratings they offer, before deciding which one or more CRAs to appoint for their rating needs. ESMA also reminds readers that the list of registered CRAs is updated annually and the calculation of CRA’s market shares, which is published every two years by ESMA. Moreover, ESMA also reiterates that issuers and/or related third parties they should document their decision not to appoint a CRA with less than 10% market share, using the Standard Form and explain the reasons for their choice. 

ESMA’s discussion in the CRA Market Share Report for 2023 concludes that the implementation of Article 8d of the CRA Regulation is expected to foster competition and diversity in the credit rating market, as well as to reduce the reliance on the ratings of the largest CRAs. ESMA also acknowledges the challenges and limitations of the market share calculation, such as the lack of data on the revenues from specific rating categories, the different business models and fee structures of the CRAs along with impact of the UK’s withdrawal from the EU and the UK moving away from EU standards on CRAs. ESMA clearly communicates that it will continue to monitor the market developments and the compliance with Article 8d, and will cooperate with the SCAs and NCAs to ensure a consistent and effective supervision of the CRA Regulation and the CMU efforts pick up on this point.

Considerations for market participants and lessons learned for revitalised CMU

The CRA Market Share Report and the 2017 SB are part of ESMA’s efforts to promote competition, choice and transparency in the CRA industry, which is essential for the development and integration of the EU’s capital markets. Issuers or related third parties who intend to use two or more CRAs for their ratings should consider the potential benefits of appointing at least one smaller CRA, as required by Article 8d of the CRA Regulation. 

In line with ESMA’s supervisory expectations and explanations of aims of Article 8d, smaller CRAs may offer more tailored, innovative or specialised ratings that reflect the specific characteristics or risks of the issuer or the instrument. They may also provide more flexibility, responsiveness or cost-effectiveness than larger CRAs. Moreover, using smaller CRAs may enhance the diversity and quality of credit ratings available to investors and regulators and reduce the reliance on a few dominant players. 

Despite this, issuers or related third parties may also face some challenges or barriers when choosing or using smaller CRAs. For instance, they may have difficulty finding a smaller CRA that has the necessary degree of relevant expertise, experience or capacity to rate their issuance or organisation. They may also encounter resistance or scepticism from investors, regulators or other market participants who are more familiar or comfortable with the ratings of larger CRAs. Furthermore, they may have to comply with additional documentation, disclosure or reporting requirements to justify their choice of a smaller CRA and to ensure that the ratings are valid, reliable and comparable. That being said, many smaller CRAs do punch above their size due to a degree of specialism and comparable conduct of business compliance performance. 

Therefore, issuers or related third parties should carefully assess the pros and cons of using smaller CRAs and weigh them against their objectives, needs and expectations of their market stakeholders plus supervisors. They should also consult with their advisers, investors, regulators and other stakeholders to ensure that their decision is well-informed, transparent and compliant. They should also monitor the performance and quality of the smaller CRAs they use and provide feedback to them and to ESMA. By doing so, they can contribute to the development and diversification of the CRA industry and the EU’s capital markets.

To achieve some the abovementioned objectives even further, efforts on completing CMU from 2024 and beyond also include priorities to enhance the role and quality of credit ratings. Use of smaller but also specialised CRAs, which may offer more tailored and innovative ratings for niche markets and sectors, and to facilitate the entry and growth of new players in the market, is encouraged. However, the CMU priorities also acknowledge that the existing regulatory framework for CRAs, which was introduced after the global financial crisis to enhance the transparency, independence, and accountability of CRAs, may pose some barriers and challenges for smaller and specialised CRAs to compete and operate in the EU market. For instance, the CRA endorsement regime, which (sensibly) allows CRAs to use ratings issued by their affiliates or third parties outside the EU, may create an uneven playing field and a competitive advantage for the large CRAs, which have a global presence and network. Moreover, ESMA and other EU policymakers not that the implementation and enforcement of existing provisions on the rotation and the use of multiple CRAs, which are intended to reduce the reliance on a single or a few CRAs and to encourage more choice and competition, may vary across the EU and may not be effective in practice. Whether this is to be reformed by any future legislative cycles following the June 2024 European Parliament elections and appointment of a new European Commission, including CMU policymakers, remains to be seen. 

Outlook

The CRA Market Share Report and supervisory expectations set out in the 2017 SB are not the only initiatives that ESMA and the EU have taken or planned to take to foster competition and choice in the CRA industry. For instance, ESMA has also issued various guidelines on the endorsement of third-country credit ratings, which aim to ensure that such ratings are subject to equivalent regulatory and supervisory standards as those issued in the EU. The EU has also advanced substantial efforts on sustainability-related disclosures in the financial services sector, which requires CRAs to disclose how they integrate environmental, social and governance factors into their ratings.

These initiatives are part of the broader agenda of the EU to complete the CMU project, which seeks to create a more integrated, diversified and resilient capital market that can support the recovery and future growth of the EU economy. The CMU project also involves other measures, such as harmonising the rules and supervision of capital market activities and participants, enhancing the cross-border access and distribution of financial products and services and promoting the development of new market segments and instruments, such as green and digital finance.

The CRA industry plays a vital role in the CMU project, as credit ratings are widely used by investors, issuers, regulators and other market participants to assess the creditworthiness, risk and performance of various entities and instruments. Therefore, it is important that the CRA industry is competitive, diverse, transparent and accountable, and that it provides high-quality, independent and reliable ratings that reflect the changing needs and expectations of the market. Smaller CRAs, as complementary alternatives to larger CRAs, have an opportunity and a responsibility to contribute to this goal. 

However, ESMA expresses its view that the CRA industry also faces some challenges and risks that may affect its development and performance. For example, the COVID-19 pandemic and the recovery plan as well as more recently geopolitical tensions and corresponding changes in monetary policy activity have created unprecedented uncertainty and volatility in the market, which may impact the demand and supply of credit ratings and the accuracy and stability of the rating methodologies and assumptions. All of this has highlighted the need for CRAs to incorporate new or emerging factors, such as sustainability, digitalisation and resilience, into their ratings even further than in respective legislative objectives. Moreover, the CRA industry may also have to adapt to the changing regulatory and supervisory landscape, both within and outside the EU, and to the increasing scrutiny and expectations of the public and the stakeholders. By doing so, specifically smaller CRAs can enhance their reputation, competitiveness and value-added in the EU’s capital markets and for interested participants. In summary, both ESMA and other SCAs recognise that in the CRA market bigger CRAs can be bountiful in benefits but smaller CRAs can offer sensible specialised alternatives for certain market participants. Market participants will want to take note of and seek to improve compliance with ESMA’s supervisory expectations in the CRA Regulation, in particular Article 8d. 

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