Credit rating agencies face additional scrutiny and restrictions from a new directive and regulation approved this week by the European Council. They are intended to reduce investors' over-reliance on external credit ratings, mitigate the risk of conflicts of interest, and increase transparency and competition within the industry.

Citing the complexity of structured finance instruments and their role to the financial crisis, the regulation requires issuers to retain at least two different credit rating agencies (CRAs) for rating them.

A mandatory rotation rule was also instituted. Issuers of structured finance products with underlying re-securitized assets who pay CRAs for their ratings are required to switch to a different agency every four years. An outgoing CRA will not be allowed to rate re-securitized products for the same issuer for a period of time equal to the duration of the expired contract, up to a maximum of four years. Mandatory rotation will not apply to small CRAs, or to issuers employing at least four CRAs each rating more than 10 percent of the total number of outstanding rated structured finance instruments. Mandatory rotation may be extended to other instruments in the future.

To mitigate the risk of conflicts of interest, the regulation also requires CRAs to disclose publicly if a shareholder with 5 percent or more of the capital or voting rights holds 5 percent or more of a rated entity. Ownership of 5 percent or more of the capital or the voting rights in more than one CRA is prohibited, unless the agencies belong to the same group.

Sovereign ratings will now be reviewed at least every six months, as opposed to the previous timeline of 12 months. The new rules also establish that investors and issuers can claim damages from a CRA if they suffer a loss due to gross negligence or malfeasance.

By July 1, 2016, the European Commission is required to review the credit rating market and issue a report on whether additional legislative proposals are called for.

The European Parliament previously approved the new rules in January. Adoption of the directive and regulation took place on May 13 at a meeting of the European Union Agricultural and Fisheries Council.