Intermediaries: Financial Analysts, Rating Agencies, and Proxy Advisors

Financial Analysts

prof. Paola Lucantoni LUISSFinancial Analysts

I. Financial analysts (FAs) are information intermediaries charged (incaricati) with the task of helping to overcome (superare) negative effects resulting from an asymmetric distribution of information on the capital markets

II. Three categories of FAS :

1. Buy-side analysts Provide analysis to support internal investment decisions (not public)
2. Sell-side analysts Produce research reports and recommendations for external clients
3. Independent financial analysts LUISSFinancial Analysts

From a regulatory perspective, there is no comprehensive set of rules regulating FAs. Specific rules on FAs can be found in:

• MAR
• MiFID 2
• Rules of conduct on insider trading and market manipulation LUISSFinancial Analysts

MAR: Article 20(1)

Persons who produce or disseminate investment recommendations or other information recommending or suggesting an investment strategy shall take reasonable care to ensure that such information is objectively presented (presentate in modo obiettivo), and to disclose their interests or indicate conflicts of interest concerning the financial instruments to which that information relates." Attention! investment recommendations' means information recommending or suggesting an investment strategy, explicitly or implicitly, concerning one or several financial instruments or the issuers, including any opinion as to the present or future value or price of such instruments, intended for distribution channels or for the public LUISSFinancial Analysts

(cont'd) information recommending or suggesting an investment strategy' means information:

(i) produced by an independent analyst, an investment firm, a credit institution, any other person whose main business is to produce investment recommendations or a natural person working for them under a contract of employment or otherwise, which, directly or indirectly, expresses a particular investment proposal in respect of a financial instrument or an issuer; or (ii) produced by persons other than those referred to in point (i), which directly proposes a particular investment decision in respect of a financial instrument LUISSFinancial Analysts

General Requirements and Expert Definition

General requirements apply to any person subject to application of MAR Additional requirements apply to a certain sub-group of these person Definition of "expert": expert' means a person referred to in Article 3(1)(34)(ii) of Regulation (EU) No 596/2014 who repeatedly proposes investment decisions in respect of financial instruments and who:

(i) presents himself as having financial expertise or experience; or (ii) puts forward his recommendation in such a way that other persons would reasonably believe he has financial expertise or experience LUISSFinancial Analysts

Special Rules for Journalists

Special rules apply to journalists disclosure or dissemination of information shall be assessed taking into account the rules governing the freedom of the press and freedom of expression in other media and the rules or codes governing the journalist profession, unless:

(a) the persons concerned, or persons closely associated with them, derive, directly or indirectly, an advantage or profits from the disclosure or the dissemination of the information in question; or (b) the disclosure or the dissemination is made with the intention of misleading (indurre in errore) the market as to the supply of, demand for, or price of financial instruments (art. 21 MAR) LUISSFinancial Analysts

Production of Research

Production of Research Rules here are fair: investment recommendations must be presented in an objective way (i.e. facts are separated from opinions) and sources must be clearly indicated Additional obligations are applicable to experts:

• The public must be informed if the advise has been disclosed to the issuer and then amended;
• Methodology disclosure LUISSFinancial Analysts

Disclosure Obligations

(cont'd) Disclosure obligations:

• Identity of the issuer
• Interests and possible conflicts of interest · Specific disclosure requirements are applicable to experts (e.g., if they hold any interest in the issuer) Investments firms, credit institutions must disclose if they have internal arrangements in order to avoid conflicts of interest LUISSFinancial Analysts

Dissemination of Investment Recommendations

Dissemination of investment recommendations Persons who disseminate recommendations produced by a third party shall communicate to the persons receiving the recommendations, among other things :

1. their identity
2. all relationships and circumstances that may reasonably be expected to jeopardise (compromettere) the objective presentation of the recommendation
3. the date and time when the recommendation is first disseminated (diffusa) LUISSFinancial Analysts

Market Manipulation

Market manipulaton Market manipulation, among other things, includes: the taking advantage of occasional or regular access to the traditional or electronic media by voicing an opinion about a financial instrument, [ ... ] while having previously taken positions on that financial instrument [ ... ] and profiting subsequently from the impact of the opinions voiced on the price of that instrument [ ... ] without having simultaneously disclosed that conflict of interest to the public in a proper and effective way" LUISSFinancial Analysts

Insider Dealings

Insider dealings (abuso di informazioni provilegiate) Insider dealing is generally forbidden (vietato)(in some cases, it is also a crime) A recommendation based on undisclosed information constitutes inside information (special rules apply in such respect) Using inside information for dealing is forbidden, even if the decision to hold an instrument is not affected by this prohibition But holding is allowed: If you already own a financial instrument and you receive inside information after your purchase, you are not required to sell it and you are not breaking the law by continuing to hold it. LUISSFinancial Analysts

Scalping

Scalping "Scalping is the practice of purchasing a security for one's own account shortly before recommending that security for long-term investment and then immediately selling the security at a profit upon the rise in the market price following the recommendation" It is considered a form of Market Manipulation and thus, forbidden LUISSRating Agencies

Rating Agencies

Foundations of Credit Rating

Foundations A credit rating is an opinion issued by a specialised firm on the creditworthiness (merito creditizio) of an entity (e.g. an issuer of bonds) or a debt instrument (e.g. bonds or asset- backed securities). This opinion is based on research activity and presented according to a ranking system. A credit rating agency (CRA) is a service provider (fornitore) specialised in the provision of credit ratings on a professional basis. The three biggest rating agencies are Standard & Poor's, Moody's and Fitch. They cover approximately 95% of the world market. Smaller rating agencies make up the remaining part. Want to give a look to all CRAS registered in EU? click here LUISSRating Agencies

The Rating Process

The process begins when a company (issuer) requests a rating from a CRA (e.g., S&P, Moody's, Fitch). Rating Request Analytical Team Appointed (nominato) Preliminary Research Company Informed Rating Committee Meeting with Management Rating Issued Appeal Process Surveillance If the issuer disagrees, it may submit additional arguments or request a review. (a straightforward representation of the rating process . Source: S&P) LUISSRating Agencies

Effects of a Rating

Effects of a rating CRAs have a major impact on today's financial markets, with rating actions impacting on investors, borrowers, issuers and governments: e.g. sovereign ratings play a crucial role for the rated country, since a downgrading has the immediate effect of making a country's borrowing more expensive (investors ask more interests because the country is risky). A downgrading also has a direct impact for example on the capital levels of a financial institution LUISSRating Agencies

Investment Grade and High Yield Ratings

Effects of a rating Investment Grade Rating Agency S&P Moody's Fitch Best Quality AAA Aaa AAA Strong Credit AA+ Aa1 AA+ Quality AA Aa2 AA AA- Aa3 AA- Upper Medium A+ A1 A+ Grade A A2 A A- A3 A- Medium/Low BBB+ Baa1 BBB+ Investment BBB Baa2 BBB Grade BBB- Baa3 BBB- High Yleld Rating Agency S&P Moody's Fitch Weak/ BB+ Ba1 BB+ Developing BB Ba2 BB Financial Grade BB- Ba3 BB- Poor Financial B+ B1 B+ Grade B B2 B B- B3 B- Highly CCC+ Caa CCC Speculative CC Ca CC Grade C C C Default D D D LUISS

The "Cliff" Effect

The "cliff" refers to the sharp drop in investor confidence and asset value when a bond is downgraded below investment grade. 2 Example: A company with a BBB- rating is just on the edge of investment grade. If it's downgraded to BB+, it falls off the "cliff": .Demand collapses, .Borrowing becomes much more expensive, ·Market perception turns negative. Beware of the «cliff> between « investment grade rating » and «Non investment grade» or High yield>Rating Agencies

Development of Regulation in EU

Development of regulation in EU The G20 summit in Washington (2008) aimed to ensure that no institution, product or market was left unregulated at EU and international levels. The EU Regulation on Credit Rating Agencies (CRA Regulation), in force since December 2010, was part of Europe's response to these commitments. The Regulation was amended in May 2011 to adapt it to the creation of the European Securities and Markets Authority (ESMA). Further amendments have been enacted (emanate) in 2013. LUISSRating Agencies

Scope of Application and Regulatory Aims

Scope of application and regulatory aims To introduce a common regulatory approach in order to enhance the integrity, transparency, responsibility, good governance and reliability of credit rating activities. Any rating which has been disclosed publicly or distributed by subscription enter within the scope of the regulation LUISSRating Agencies

Regulatory Strategies for the Issuer-Payer Model

Regulatory strategies to tackle the "issuer-payer" model It is the model in which the issuer - that is, the company or government seeking to receive a rating - pays the credit rating agency (CRA) to obtain it. Avoidance (prevenzione) of conflicts of interest a) To prevent conflicts of interest, new regulations require: ·Public disclosure if a shareholder owning 5% or more of a Credit Rating Agency (CRA) also holds 5% or more of any entity rated by that CRA. ·A strict prohibition: No shareholder who owns 10% or more of a CRA's capital or voting rights is allowed to also hold 10% or more in any rated entity. To ensure that credit ratings remain objective and independent, without undue influence from major shareholders who have interests in rated companies. LUISS