New York–The U.S. Senate Banking Committee held a hearing last week to castigate the ratings agencies and prod the Securities and Exchange Commission to increase its oversight. Post-Enron, the ratings agencies were a Congressional afterthought, with legislation giving the SEC explicit authority to regulate ratings agencies passing in 2006, five years after Enron’s bankruptcy. With the subprime crisis, ratings agencies are at the top of the Congressional hit list, and last week’s hearings gave the SEC the opportunity to float some its pending ideas. Chairman Cox listed a variety of potential initiatives, but it is likely that Congress will demand more.
The SEC approach boils down to more disclosure and continued attempts to increase competition within the oligopolistic ratings industry. The Credit Rating Agency Reform Act of 2006 was primarily intended to begin to level the playing field by making it easier for rating agencies to receive the imprimatur of “Nationally Recognized Statistical Rating Organizations” (NRSROs). NRSROs are referenced in myriad regulations and legislation, from rules governing U.S. money market purchases of short term securities to state pension fund investment guidelines, increasing investor demand for ratings.
Since the passing of the legislation and the SEC’s implementation of a regulatory program in June 2007, four new NRSROs have been designated by the SEC. Two Japanese ratings agencies (Japan Credit Rating Agency and R&I), Egan-Jones Rating Company and LACE Financial were approved. None of the firms are new entrants and most have had NRSRO applications pending for decades. Egan-Jones and LACE, which rates financial institutions using a quantitative model, are both subscription based. However, boutique firms such as CreditSights or Rapid Ratings have not applied, nor have any large information firms such as Morningstar or Bloomberg.
Some of ideas floated by Chairman Cox last week might entice additional applications, particularly the idea of requiring the disclosure of data on structured deals to all NRSROs so that any firm, including those relying on subscription models, have the necessary information to determine a rating. Ratings on structured products have been a barrier for firms with a subscription based business model because issuers have historically only provided the necessary information to the ratings agencies they are hiring for the ratings.
The other deterrent is concern about what other backlash there might be against NRSROs. One idea that Cox did not float was increasing the liability of ratings agencies for bad ratings by removing their exemption from ‘expert status’, which underwriters and other parties involved with new issues must bear. This idea is floating around Congress, however, and potential NRSROs are taking a ‘wait and see’ approach. Cox indicated that the SEC’s full report on ratings agencies is scheduled for release in the summer, and will include a more concrete set of proposed rules.
The full text of Cox’s remarks can be found at http://www.sec.gov/news/testimony/2008/ts042208cc.htm.
The following summary of Cox’s ‘trial balloons’ has been provided by Williams & Jensen PLLC:
- Proposed rules may include requirements for enhanced disclosures about ratings performance to better enable comparability of credit ratings with another.
- Proposed rules may include specific prohibitions on certain practices, as well as the establishment of requirements to address potential conflicts that could impair the process for rating structured products.
- The proposal may require the disclosure of information about the assets underlying the MBS, CDOs and other structured products they rate.
- The proposal may also consider enhanced disclosures about how NRSROs determine their ratings for structured products, such as the manner of analysis of the mortgages’ conformance with underwriting standards.
- The proposal may require the disclosure of ratings information to make it possible for investors to distinguish among ratings for different types of securities, such as structured products, corporate securities, and municipal securities.
- The SEC may also consider ways to ensure that all NRSROs have access to the information underlying credit ratings.
- The Commission is reconsidering its reliance on and references to NRSRO credit ratings in its own rules.