Thursday, June 12, 2008

SEC rating agency proposals

(FT Alphaville) A quick take on the latest facing the rating agencies. The first set of new regulatory proposals, released by the SEC yesterday (emphasis ours):

The Commission is proposing the rulemaking in three parts, with the first two portions being proposed today and the third portion to be considered on June 25.

The first part of the Commission’s rule proposal would:

- Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available.

- Prohibit credit rating agencies from structuring the same products that they rate.

- Require credit rating agencies to make all of their ratings and subsequent rating actions publicly available. This data would be required to be provided in a way that will facilitate comparisons of each credit rating agency’s performance. Doing this would provide a powerful check against providing ratings that are persistently overly optimistic, and further strengthen competition in the ratings industry.

- Attack the practice of buying favorable ratings by prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it.

- Prohibit gifts from those who receive ratings to those who rate them, in any amount over $25.

- Require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category, in a way that facilitates comparison with their competitors in the industry.

- Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product.

- Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.

- 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 rating agency’s Web site. That would permit easy analysis of both initial ratings and ratings change data.

- Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.

- Require documentation of the rationale for any significant out-of-model adjustments.

(It is curious that the SEC has chosen to specifically target gift-giving. Clearly there was reason to._

As always, the impact of the above rules, will very much depend on the manner in which they’re enforced. It’s certainly not the worst possible outcome for the rating agencies, but it’s a turn of the screw which should make life a lot harder in the future.

Will democrat lawmakers on Capitol Hill be satisfied? That very much depends of the outcome of any enforcement action the SEC may - or may not - be undertaking.

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