Thursday, June 12, 2008

Regulators raise fears over 'hardwired' credit ratings

(FT) US regulators yesterday raised concerns about their reliance on the credit ratings that are "hardwired" into the financial system as they revealed proposals aimed at addressing conflicts of interest in the industry.

Christopher Cox, chairman of the Securities and Exchange Commission, said the agency would consider whether to reform many of its rules "that make explicit reference to credit ratings."

He added: "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 . . . our own rules may be contributing to an uncritical reliance on credit ratings as a substitute for independent evaluation."

His statements mark one of the clearest signs yet that global regulators are re-examining the degree to which their own regulatory frameworks have become dependent on credit ratings.

Over the last decade, the regulators have allowed credit ratings to be used to determine the appropriate level of capital that banks need to hold. This pattern has prompted criticism that these ratings have now been "hardwired" into the system.

Some observers, including the Financial Stability Forum, have indicated that the official recognition of credit ratings for a variety of securities regulatory purposes may have played a role in encouraging investors' over-reliance on ratings.

Mr Cox's comments came as the SEC proposed a set of new rules for ratings agencies, including a controversial plan requiring them to differentiate the ratings they use on structured finance products - which are at the heart of the credit crisis - from those they issue on traditional corporate bonds.

Agencies could differentiate the ratings by either using different symbols, such as "sf" (for structured finance) - or by issuing a report disclosing the differences between ratings of structured products and other securities.

However, the idea is seeing heavy resistance from many financial market participants as well as from some SEC officials who say that such a proposal would scare away investors.

Paul Atkins, a commissioner, said the new symbol requirement would be like a "scarlet letter" while the alternative option would be costly. The Securities Industry and Financial Markets Association said there were possible serious consequences for markets if credit ratings scales are changed.

Many investors have guidelines based on a ratings scale used for corporate, municipal and structured finance investments. If the ratings scales change, many investors would have to go through an internal process to gain approval to buy bonds with the new ratings.

Under the proposals, which were released for public comment, ratings agencies would also have to reveal more information about their ratings for structured finance products and take steps to prevent conflicts of interest. For instance, agencies would not be allowed to structure the same products they rate and anyone who helps determine a rating would be prohibited from fee negotiation.

No comments: