Home » Industry » Rating Services » Tough New Regulating Regime Takes On Rating Agencies

Tough New Regulating Regime Takes On Rating Agencies

With legislators on Capitol Hill ready to put the shackles on Wall Street, few segments of the financial industry are going to be impacted more than the Nationally Recognized Statistical Rating Organizations (NRSRO), or otherwise referred to as credit rating agencies.   For starters, NRSROs will experience more regulation than they ever have. With the passage of H.R. 4173 last December, and the passing of the S.3217 this past May, President Barack Obama signed this landmark legislation into law on July 21, 2010.

Dodd-Frank (US legislators) will do a number of things. First, NRSROs will be forced to “establish an internal control structure” that will document and police processes with regards to the reforms. An annual internal controls report must be submitted to the Securities and Exchange Commission; it will contain such items as the effectiveness of the control structure and attestations from the CEO.  The SEC, with expanded powers, will also be able to revoke the NRSROs’ registration if ratings are produced without “integrity”.  One important aspects of this bill will be the establishment of the Office of Credit Ratings. This Office will monitor rating agency behavior, will promote accuracy in the issued ratings, and will make sure that ratings are not unduly influenced by any conflicts of interest. It will conduct annual reviews of NRSROs. 

The regulatory reach of the SEC will also extend further than ever: for instance, a report must be filed if any person leaves an NRSRO for a company that has received ratings from that agency in the previous five years. This employee must not have “performed credit ratings, participated in the development of ratings methodologies or models, perform[ed] marketing or sales functions” or established compensation levels for the company that hired him or her from the NRSRO within the previous five years. It also must conduct periodic reviews to ensure that these NRSROs are complying with this “look-back” requirement.  To promote unparalleled levels of transparency in the industry, each agency must publicly disclose all ratings, as well as information that was used to decide the rating. The bill also lays out the corporate structure that the agencies must follow.  The Franken Amendment added a prime example of this new power to the bill. This amendment states that initial credit ratings on structured finance products must be provided on a random, or semi-random basis, meaning that issuers of structured finance will not choose the NRSRO that provides their initial ratings. The SEC will have the power, and the duty, to change this provision if a more efficient process arises, but this will be the common course of action going forward.

Needless to say, the conversation about the current happenings in the credit rating industry must begin and end with Dodd-Frank. This new legislation has the potential to have a profound impact on the industry. The transparency with which business will be conducted in the next few years, as well as the distant future, will change the ratings game.

One major implication of the legislation has already presented itself as several of the major NRSROs have gone on ‘strike’.  The key issue deals with the liability of NRSROs whose ratings are used in prospective analyses or offering statements. Before Dodd-Frank, plaintiffs were able to sue any company whose ratings provisions turned out to be wrong in these initial offering statements; however, NRSROs were exempt from this liability. Under the new rules, NRSROs will not be exempt from culpability, but they will now have the power to withhold ratings from these offering statements. 

With this liability issue dangling over their heads, NRSROs will in future be super cautious with any ratings they are being asked to issue. The consequences will be longer rating processes, stiffer due diligence, lower ratings (meaning high interest rates for the issuer) and less availability of credit for cash starved industries.  Perhaps a new credit crunch may be the result of it.   That of course could strengthen the hands of the NRSROs in their battle with the SEC and the eventual outcome may be entirely different to what Congress had intended.  One thing is certain, for NRSROs, issuers and investors the business of ratings has already dramatically changed.    John Morris, BIIA Staff Writer

Works Cited:  U.S. House of Representatives. “Dodd-Frank Wall Street Reform and Consumer Protection Act: Conference Report.” 111th Congress, 2nd Session (June 29, 2010 <http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/conference_report_FINAL.pdf>

U.S. Senate. “Bill Summary & Status: S.Amndt.3991.” 111th Congress, 2nd Session (May 12, 2010). < http://thomas.gov/cgi bin/bdquery/D?d111:3:./temp/~bdxViV::|/home/LegislativeData.php|>

BIIA Newsletter July II – 2010 Issue

Leave a Reply