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Rating Reform is underway: ISA approved the Bill regulating supervision of rating companies

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Rating companies will be required to register with the ISA and comply with the following requirements – regulation of potential conflicts of interest, conflicts of interest, ensuring reliability of information used by the companies for rating purposes and transparency of the rating process. 
 
Supervision reform of rating companies is underway. The plenum of the ISA has approved the Bill regulating the activities of the rating companies and making it subject to the ISA supervision. The proposed law is aimed at ensuring the reliability, quality, equality and independence of the rating process.
 
Rating companies provide professional opinions evaluating the ability of debtors to comply with their financial obligations, as well as evaluation of assets and other business activities. Ratings, issued by rating companies, narrow the information gap existing between lenders and borrowers regarding the debtors’ ability to repay the debt.
 
During the last years the development of financial engineering and the Basel 2 Report, widened the scope of activities in which rating companies are currently involved. Both the sub-prime and the credit crises revealed failures in the functioning of the aforesaid companies, which were mainly related to rating practices, conflicts of interest and lack of transparency as regards the rating process.
 
The failure of rating companies, to make proper rating assessments, was intensified by the fact that most investors relied heavily on the published rating results while making their investment decisions. The central role played by the rating companies in the crises, led the regulators (from Europe, US and other counties) to the conclusion that there is a need to reexamine and deepen the regulation of this field. 
 
Following the aforesaid global changes it was concluded that Israel must also improve its existing regulation of the rating activities, and to tighten the supervision over them on the basis of practices commonly accepted in other developed countries.
 
Under the agreement arrived at by the local regulators, the ISA will be responsible for the regulation and supervision of the rating field.       
 
The Bill, proposed by the ISA, stipulates that only registered rating companies shall be authorized to issue ratings. In order to register the rating companies will have to comply with certain qualifying conditions, including: managerial and operational requirements, independence and conflicts of interest requirements, credibility of management and controlling shareholders, employment of qualified staff and companies’ supervision of their professional functioning.         
 
Once the rating companies are registered they will be obligated to limit the conflicts of interest in their work, as well as potential conflicts of interest, ensure the reliability of information on which the rating is based, and to increase the transparency of the rating process. Furthermore, all rating companies will be required to disclose their rating methodology, to ensure the reliability of rating; the scope of disclosure will be determined by Law.           
 
The ISA also proposes determining the powers of supervision and enforcement as regards the activities of the rating companies, including the imposition of civil, administrative and criminal sanctions for the violation of the Law. The ISA will be authorized to impose heavy financial fines, in accordance with the three levels of offences defined by law. The fine of violating the first level of offences will be 1/2 a million NIS, for violations of the second and third levels – up to 2 million NIS. Violation of the Law, with intent to mislead or defraud a reasonable investor will be punishable by a maximum of five years in prison or high financial fine. Engagement in rating activities without license will be punishable by up to two years in prison or high financial fine.      
 
The proposed Bill deals not only with the credit rating companies, but with the overall regulation of all rating companies such as – trust fund rating companies, etc.
 
It is possible that regulations which will be added to the Law later on, will deal individually with various rating companies, according to their field of activities.  

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