Friday, April 11, 2008

SEC to propose rules on ratings conflicts

(FT) Proposals for rules governing potential conflicts of interest at credit rating agencies are likely to be drawn up by US regulators in the next few months, according to a senior staff member at the Securities and Exchange Commission.

The proposals come amid a broad review of the industry being conducted by the US markets watchdog, said Erik Sirri, director of the trading and markets division at the SEC.

He added that the agency was also examining its own reliance on ratings when making some market rules.

The credit rating agencies, which are paid by the issuers whose securities they rate, have come under criticism amid the market turmoil, not least because investors often rely on their ratings when deciding whether to buy or sell securities.

In recent months, all three main credit raters – Standard & Poor’s, Moody’s Investors Service and Fitch Ratings – have been forced to downgrade a slew of US bonds backed by subprime mortgages, on which default rates have risen abruptly.

Some critics say the agencies failed to act quickly enough to warn investors about the risks of investing in complex securities, such as those backed by US subprime mortgages.

“We are looking inside to see if there is evidence [of conflicts of interest],” said Mr Sirri.

He declined to be specific about the proposed rules being developed, but they could address broad issues, including the separation of the fee negotiation and ratings processes, and greater disclosure about the ratings process.

“The hope is that other third parties can look at the models, validate the models and fact-check the models,” Mr Sirri told the Council of Institutional Investors on Thursday.

However, any proposed rules can only be ultimately imposed by the Commission itself.

The ratings agencies themselves have started to tighten their own policies on managing conflicts of interest and so enhance the quality of ratings, but the focus of regulators on their role in markets is likely to continue.

In its policy statement last month, the US president’s working group on financial markets – made up of the heads of the SEC, the Treasury, the Federal Reserve and the Commodity Futures Trading Commission – said ratings agencies should disclose conflicts of interest and distinguish more clearly between the ratings they give to structured products and ordinary debt.

Separately, commenting on the recent demise of Bear Stearns, which collapsed after suffering a sudden loss of liquidity, Mr Sirri said the SEC could push for longer-term and diversified funding for the Wall Street banks it supervises.

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