The U.S. Securities and Exchange Commission today proposed a series of reforms to the credit rating business that are intended to bring increased transparency to the ratings process and curb practices that it believes contributed to recent turmoil in the credit markets.
The SEC is proposing the rulemaking in three parts, with the first two portions being proposed today and the third portion to be considered on June 25.The first part of the commission’s rule proposal would, among other things: prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available, prohibit CRAs from structuring the same products that they rate, require CRAs to make all of their ratings and subsequent rating actions publicly available, prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it, require CRAs to publish performance statistics for one, three, and 10 years within each rating category, in a way that facilitates comparison with their competitors, along with requiring various beefed up disclosures.
The second part of the commission’s proposal would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds, either through the use of different symbols, such as attaching an identifier to the rating, or by issuing a report disclosing the differences between ratings of structured products and other securities.
The third set of recommendations for the commission’s proposal, which will be considered later this month, are being designed to ensure that the role the SEC has assigned to ratings in its rules is consistent with the objective of having investors make an independent judgment of risks and of making it clear to investors the limits and purposes of credit ratings for structured products.
“The events of recent months have had a profound effect on our economy and our markets, and they have galvanized regulators and policymakers not only in this country but around the world to re-examine every aspect of the regulatory framework governing credit rating agencies,” said SEC chairman Christopher Cox. “This package of proposed rules would foster increased transparency, accountability, and competition in the credit rating agency industry for the benefit of investors.”
In response to the proposals, Fitch Ratings commended the SEC for its ongoing efforts to enhance the transparency and independence of credit ratings. Fitch said it agrees with the commission that investors and other market participants should make their own independent judgments of credit risk.
Public comments on today’s proposed amendments and rule must be received by the commission within 30 days. It remains to be seen how the proposals are received by the industry and investors. For example, the idea that rating agencies should publish separate rating scales is one that has met some resistance from the industry.
A number of the proposals discussed today are positive steps forward, said Fitch CEO, Stephen Joynt. “For example, additional disclosure of the information on the underlying assets in structured finance securities should enhance transparency in the market. However, it may be most practical for issuers to provide that information to the market prior to securities’ sales,” he said.
“It is important that the investor community play an active role in the review of the SEC’s proposed rules. We encourage investors to work with the SEC in ensuring the adoption of practical and clearly beneficial final rules,” he added.
The U.S. Securities Industry and Financial Markets Association’s Credit Rating Agency Task Force argued that separate ratings for structured products are not necessary.
In a letter to the SEC’s commissioners, SIFMA’s task force argued that adverse consequences could result if existing credit rating scales are changed. “We applaud the SEC for focusing on transparency and disclosure. Ratings modifiers, however, are not the answer,” said Boyce Greer, co-chair of the task force and president of Fixed Income & Asset Allocation at Fidelity. “What’s needed is greater transparency in the analytics and credit evaluation that underlie the rating.”
“As a sound bite, modifiers are appealing,” noted Deborah Cunningham, co-chair of task force and chief investment officer of Federated Investors. “But they would be a completely cosmetic solution to a fundamental problem that is better addressed at the source – the substance that underlies the rating.”
The letter points out that the credit rating modifier proposal could, “impair capital raising (for student loans, auto loans, credit cards, mortgages, and the like), and lead to the sudden sale of structured finance securities, at fire-sale prices, into an already highly illiquid market at a time when our financial markets can ill afford such an unnecessary shock.”
@page_break@“We appreciate the SEC’s sensitivity to considering carefully the unintended consequences that such a change might trigger, before the commission adopts any final rules,” said Cunningham. “When you pull on a string, it is usually a good idea to consider what might unravel. The possible consequences for our markets if rating modifiers are adopted could be disturbing.”
The task force recommends that the focus be on the credit rating agencies enhancing disclosure of collateral credit quality characteristics. It is also working with credit rating agencies to develop agreed–upon recommendations this summer.
Proposed SEC reforms intended to increase transparency of credit rating process
Rating agencies would differentiate ratings they issue on structured products from those they issue on bonds
- By: James Langton
- June 11, 2008 June 11, 2008
- 14:50