At its open commission meeting this morning (June 11), the SEC voted to release two proposed rules relating to credit ratings and credit rating agencies. A third proposed rule will be considered on June 25. Chairman Christopher Cox, Commissioner Paul Atkins, and Commissioner Kathleen Casey unanimously agreed on the first proposal, Atkins dissented from the second. Here is the SEC's press release, some highlights of the meeting based on listening to the webcast are provided below.
As detailed in Chairman Cox’ opening statement, the proposals “would regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies.” He added that although the proposals are largely the work of the SEC's Division of Trading and Markets, they “reflec[t] the input of several of the Commission's … Divisions and Offices, as well as a number of international regulatory organizations that have studied these issues, including the Financial Stability Forum and the International Organization of Securities Commissions [IOSCO].”
The first proposal approved for release today would, among other things:
Prohibit a credit rating agency (CRA) from structuring the same products that they rate,
prohibit CRAs from rating structured products unless information on assets underlying the product were available,
require disclosure by CRAs of the way they rely on the due diligence of others to verify the assets underlying a structured product,
require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and
require the maintenance of an XBRL database of all rating actions on the CRA’s website.
The second proposal approved today (with a 2-1 vote, Atkins dissenting) would require credit rating agencies (CRAs) 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 report would have to be issued by the CRA each time it publishes a credit rating for a structured finance product, and would be required to describe:
o the rating methodology used to determine the credit rating and how it differs from the determination of a rating for any other type of obligor or debt security, and
o how the credit risk characteristics associated with a structured finance product differ from those of any other type of obligor or debt security.
Atkins explained his dissent from the second proposal, referred to informally as the ‘symbology’ proposal due to its option of providing a new rating symbol for structured finance products. He noted the fact that structured finance products differ from other securities “ought not to come as a revelation” to investors in those products, who tend to be institutional (sophisticated) investors, and although ‘the scarlet letter’ of ‘the dreaded SF ratings” (for Structured Finance) may go away, he observed “the tenuous benefits of the proposal could come with quite a cost,” and additionally, he questioned f some parties would find a way to essentially structure around the process to avoid the SF rating.
In terms of cost, Atkins noted not only direct costs incurred by CRAs, but also costs to the economy arising from the fact that certain institutional investors (e.g. insurance companies, pension funds) may be prohibited from investing in other than certain classes (ratings) of securities. Thus, if the ‘-SF’ - or ‘Dot-SF’ designation, as Atkins referred to it - is not among the permitted ratings designations for some institutional investors’ investment portfolios, unintended economic consequences could include potentially forcing those institutions to liquidate those prohibited holdings from their portfolios, thereby depressing the market further for those securities. He noted federal and state regulators and others could amend their rules (and presumably funds would need to amend their governing documents) to account for the new ratings symbols, but those amendments could take time and be costly.
“The major underlying question for me,” said Atkins, “is whether we have the underlying authority,” to require this change in symbology. Referencing the basis for that section of the proposal, he added, “the constructed books and records bootstrap seems tenuous at best, it is clear under [the Credit Rating Agencies Reform Act] that we not micromanage the ratings process, particularly where some ratings agencies see symbols as a proprietary matter.”
The third proposal to be considered at SEC’s June 25 meeting, said Cox, will address: “To the extent that the SEC’s references to credit ratings in our rules are viewed by the marketplace as giving credit ratings an implied official seal of approval, [some have argued that] our own rules may be contributing to an uncritical reliance on credit ratings as a substitute for independent evaluation.”
In anticipation of the June 25 meeting, Commissioner Atkins noted there would be “a real benefit in removing the government imprimatur” implied in the SEC’s current rules with respect to credit ratings.
Commissioner Casey concurred that it is “vital that market participants and regulators do not put undue reliance on these ratings.” Although she voted with Chairman Cox to release the proposed rule on ‘symbology’ (option of new symbols or reports), to get constituents’ input through the comment period, she cautioned against adding what may be ‘largely symbolic gestures’ that may add cost and unintended consequences.
Additional details from today’s SEC meeting can be found in this FEI summary. (Summary can only be downloaded by FEI members, see info on FEI membership.)
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