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The US’s financial regulatory supervisor, the Securities and Exchange Commission (SEC), yesterday voted to formally propose a comprehensive series of credit rating agency reforms to bring increased transparency to the ratings process and curb the practices that have contributed to the sub-primes crisis.
As expected (see "Regulation – Second barrel fired at Credit Rating Agencies", Chase Cooper News, 6th June), the SEC plans a detailed set of new conduct rules for the agencies, particularly in the area of structured products. The changes proposed are in three parts, with the first two parts proposed yesterday, with the third following on June 25. There is a 30 day public comment period. The first proposals are:
- Stronger controls are needed in the form of better capital, liquidity and risk management levels – these should be set high enough to discourage usage of central bank liquidity, but not too high in that they push capital to unregulated areas.
- Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product is available, or from structuring the same products that they rate. The information used for a rating a structured product, including on the underlying assets, must be disclosed.
- Prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it, or from receiving gifts from those they rate.
- Require disclosure by the rating agencies of all ratings and subsequent rating actions, of their reliance on the due diligence of others, on how frequently ratings are reviewed, on whether different models are used for ratings surveillance than for initial ratings, whether changes made to models are applied retroactively to existing ratings, and any significant out-of-model adjustments.
- Require performance statistics for 1, 3, and 10 years within each category, and to make an annual report of the number of ratings actions they took in each ratings class.
The second part of the SEC’s proposal requires agencies to differentiate the ratings they issue on structured products from those they issue on bonds. The third set of recommendations is being designed to ensure the SEC’s objectives of rating agencies providing the necessary independent judgments required by investors.
Erik Sirri, Director of the SEC's Division of Trading and Markets, said, "The rules proposed today are designed to improve investor understanding of credit ratings through enhanced disclosure of NRSRO (Nationally Recognized Statistical Rating Organization) methods and performance data, and to promote investor confidence in credit ratings by minimizing conflicts of interest."
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