Companies that rely on the Big Three credit rating agencies will be forced to seek credit opinions from smaller rivals under European Union plans to increase competition.
Policymakers describe the global dominance of Moody's , Fitch Ratings and Standard & Poor's as an oligopoly.
EU Internal Market Commissioner Michel Barnier is expected to publish his draft law on November 15 to mandate rotation of agencies, a copy of the draft seen by Reuters showed.
An initial consultation signalled companies would have to switch agencies every nine years. However, this has now been toughened up because seeking to boost competition by setting up a new European agency is proving difficult.
This rotation rule is expected to significantly mitigate the conflicts of interest related to the issuer-pays model, the draft said.
Policymakers have been unhappy that agencies are paid by the companies they rate, but there are few alternatives.
People familiar with the industry say the rotation rule would be a game changer and force many companies to switch agencies within a year of the new law taking effect.
Under the rotation rule:
** An agency would only be allowed to rate a corporate issuer or its debt, as opposed to both at present
** There would have to be rotation between issuers every three years, followed by a cooling down period of four years
** There would have to be rotation after one year once the agency had rated 10 financial instruments in a row for the same issuer
** Lead rating analysts must not be involved in rating the same company for more than four years
** The rotation rule will only cover corporate debt and structured finance, with sovereign debt exempted
If approved by EU states and the European Parliament, it would mark a big shake-up because many corporates, such as banks, have ratings from two -- if not all of the Big Three -- at the same time to reassure markets and attract investors.
The draft law also looks at ownership of agencies, which could prompt a restructuring of the Big Three.
If the agency is listed, as the leading trio are, its shareholders could be barred from investing in any company the agency rates. The agency also may not be allowed to rate a company that its shareholders have a stake in.
Agencies could end up becoming limited partnerships.
As flagged, regulators could temporarily ban sovereign ratings in particularly exceptional circumstances, comprising imminent changes to the creditworthiness of a state, immediate threat to financial stability and excessive volatility.
Some officials believe this would be unworkable because the blackout would have to be announced, sending investors scurrying for the exits.
Policymakers accused raters of making it more expensive to bail out Greece by issuing downgrades during debt negotiations.
Sovereign rating changes could only be published after the close of markets or at least an hour before the opening of markets in the EU, according to the draft.
The Commission had floated the idea of forcing agencies to give countries three days' notice of a rating change, but this appears to have been dropped. Instead, the current 12 hours notice is redefined as a full working day before publication.
A major aim is to reduce the financial industry's heavy reliance on ratings, such as for determining the size of a bank's capital buffers or when to pull out of an asset.
Financial institutions ... should therefore avoid relying solely or mechanistically on external credit ratings for assessing the creditworthiness of assets, the draft says.
The United States has adopted a law to formally strip the use of ratings from financial rules, but is finding it tough to implement this.
The EU draft also says issuers of structured finance products would have to engage two agencies to rate these. In the run-up to the financial crisis, such products were often highly rated but became toxic during the credit crunch.
Investors would also be able to sue agencies under civil law for having relied on an incorrect rating.
(Editing by David Hulmes)