By Soyoung Ho
A senior SEC official solicited feedback about ways to improve the rules that apply to nationally recognized statistical rating organizations (NRSROs). These are credit rating agencies regulated by the commission.
Much has changed since the financial crisis of 2008 when the credit rating business was cited as a particular source of trouble. Credit rating agencies are paid by the public companies they assign ratings, and they were found to have assigned triple-A or other investment grade designations on securities of questionable value. In many cases, the mortgage-backed bonds and similar securities that were graded highly plummeted in value as the crisis mounted. Since then, the SEC has instituted a number of reforms intended to reduce the markets’ reliance on credit ratings and encourage market participants to carry out independent reviews of securities and not consider an agency-assigned rating a substitute for an objective evaluation of a financial instrument.
Credit ratings agencies have made improvements to their operations since the SEC began its annual exams of the firms almost a decade ago, but more can be done, said Jessica Kane, director of the SEC’s Office of Credit Ratings (OCR), in a speech in Las Vegas, Nevada, on February 24, 2020.
In particular, Kane said she wants the public’s input on conflicts-of-interest rules in Rule 17g-5(a)(3) of the Securities Exchange Act of 1934. The provision requires rating agencies to maintain a password-protected web site on the structured finance deals they rate so that rivals can gather data to prepare ratings independently of the primary rating firm. Issuers are required to supply the rating agency with the data for the website and keep them current. The rule was mandated in November 2009 in Release No. 34-61050, Amendments to Rules for Nationally Recognized Statistical Rating Organizations. (See Extra Disclosure Requirements for Rating Agencies Included in Release No. 34-61050 in the November 25, 2009, edition of Accounting & Compliance Alert.)
“The purpose of the program is to enable non-hired NRSROs to use the information to produce unsolicited ratings on structured finance products, thereby providing the market with more credit views and potentially identifying ratings that may have been influenced by the issuer-pay conflict of interest,” Kane said. “In light of comment received suggesting that the program is not achieving the Commission’s goals, the Commission directed staff to further evaluate the effectiveness of the program overall.”
Kane said her office wants input about what changes could enhance the effectiveness of Rule 17g-5(a)(3). She asked whether credit agencies should be able to access the 17g-5 website data to produce commentaries. She also wanted to know whether there are other ways to address the issuer-pay conflict of interest.
The commission’s Fixed Income Market Structure Advisory Committee (FIMSAC) is also considering whether there are alternative payment models for NRSROs that would better serve investors. (See SEC’s Fixed Income Market Advisory Panel to Meet in February in the January 23, 2020, edition of ACA.)
In addition, Kane said as OCR engages with users of credit ratings about improvements to regulation, the staff is also considering the following:
- Whether additional disclosures would lead to more informed investment decisions by retail and institutional investors, for example, more tailored disclosures by asset class or type of rated security, and disclosure regarding economic stress assumptions;
- Whether more timely NRSRO disclosure around performance of rated bonds and structured products, such as through performance scorecards or other indicators of performance, would improve information quality and make it easier to assess the quality of NRSRO ratings; and
- Whether additional disclosures about methodologies and deviations from those methodologies would help in assessing credit ratings.
This article originally appeared in the February 27, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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