Today, the House Committee on Financial Services’ Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises held a hearing entitled “Reforming Credit Rating Agencies.” Subcommittee Chairman Paul E. Kanjorski (D-PA) opened the hearing by summarizing his proposed legislation regarding credit rating agency reforms. Several other members also made opening remarks, including Representative Scott Garrett (R-NJ) who thought the proposed legislation goes too far in that it would impose collective liability on the credit rating agencies. In his view, increasing litigation exposure is not a constructive way to improve the ratings agencies. Other members thought the proposal does not go far enough, such as Representative Brad Sherman (D-CA), who said that ratings need to be made more reliable, and that it is not enough to warn market participants that they might not be reliable.
Testifying before the committee were the following individuals:
- Daniel M. Gallagher, Co-Acting Director, Division of Trading and Markets, U.S. Securities and Exchange Commission (SEC)
- Raymond McDaniel, Chairman and Chief Executive Officer, Moody’s Corporation (Moody’s)
- Deven Sharma, President, Standard & Poor’s (S&P)
- Stephen W. Joynt, President and Chief Operating Officer, Fitch Inc. (Fitch)
- Robert Dobilas, President and Chief Executive Officer, RealPoint LLC
- James H. Gellert, President and Chief Executive Officer, Rapid Ratings International Inc.
- Kurt Schacht, Managing Director, CFA Centre for Financial Market Integrity
Mr. Gallagher began by noting that the SEC “has been active in its rulemaking and oversight with respect to credit rating agencies as nationally recognized statistical rating organizations (“NRSROs”).” In June 2007, the SEC adopted six rules and an application form for NRSROs pursuant to its authority under the Rating Agency Act, which was enacted by Congress in September 2006. At the end of 2007, the staff of the SEC began an examination of the three largest NRSROs. As a result of the examination, the SEC issued recommendations to the NRSROs involved and has been continuing to monitor the examined NRSROs as they address the examination findings.
On September 17, the SEC proposed further rules “designed to (1) promote greater accountability, (2) foster competition, (3) decrease the level of undue reliance on NRSROs, and (4) empower investors to make more informed decisions.” Among other items, the new rules would create a mechanism to provide all NRSROs with access to the same information to rate structured finance products so that all NRSROs, regardless of whether they have been hired, can provide unsolicited ratings in the structured finance market. The SEC also has removed references to NRSRO credit ratings in certain of its rules and forms to try to eliminate undue reliance on those ratings by market participants.
Mr. McDaniel stated that Moody’s generally supports the draft legislation. However, Moody’s does not believe that it is appropriate for a board of directors of a credit rating agency to provide oversight with respect to the content of their methodologies. Moody’s is also opposed to provisions that would impose a collective liability regime on all NRSROs. “Historically, litigation pursued against [credit rating agencies] has come from issuers. This indicates that pressure created by a new liability standard will likely come again from issuers who would threaten litigation in an attempt to coerce [credit ratings agencies] into issuing higher ratings or refrain from taking a negative rating action.” Moody’s also does not believe that the disclosure of preliminary ratings will deter ratings shopping because issuers will just start the “shopping” earlier in the process. Instead, Moody’s proposes that issuers should be required to make more detailed information, as well as ongoing performance data, available to the general public at issuance.
Finally, Moody’s does not believe that shifting away from an issuer pays model would eliminate conflicts of interest. First, investors can be just as motivated to influence credit ratings agencies as issuers. Second, there is not always a clear distinction between issuers and investors. Finally, issuers would still be able to employ other financial means to try to influence credit rating agencies. Given that both models create conflicts of interests, the question should be which provides more advantages. Mr. McDaniel believes that the issuer-pay model does because it allows all rating actions to be released to the general public simultaneously at no cost to investors.
Mr. Sharma testified that S&P also generally supports the proposed legislation. “We also share the general view that through greater disclosure, oversight and accountability, confidence in ratings can be restored to overcome the recent disappointment in some ratings of residential mortgage-backed securities and related products.” At the same time, S&P believes that many of the proposals would bring unintended harm to the markets. These proposals include amendments to federal securities laws that would impose a negligence standard as opposed to a fraud standard on credit rating agencies. He also noted that S&P would be extremely concerned with any regulatory measures that could force analysts to make judgments “not based upon their own considered analysis and independent views and experience, but rather out of a desire to avoid subsequent second-guessing by regulators or others.”
Mr. Joynt stated that Fitch is disappointed that the regulators have not yet addressed enhancing public disclosure in structured finance securities. “Fitch has repeatedly suggested that the information made available to the rating agencies as part of the rating process for securitization be made available to all investors, and that responsibility for disclosing that should rest with issuers.”
Mr. Dobilas testified that the proposed legislation would decrease competition from smaller firms like his own. “We are very concerned about the proposal to make all NRSROs ‘jointly liable’ for a civil judgment if the agency being sued is unable to satisfy the judgment. This is an unprecedented concept with respect to the inter-relationship of competing companies and it is particularly inappropriate for smaller companies like Realpoint to be guarantors for our multi-billion dollar competitors.” He also stated that the proposed legislation would require NRSROs to publicly disclose information on initial ratings and subsequent ratings. “Without a substantial time lag, this requirement is antithetical to the subscriber-based business model since selling this information is how we produce our revenues.”
Mr. Geller encouraged the regulators not to take a one-size-fits-all approach. Mr. Geller noted that subscriber-paid credit rating agencies are most at risk under the proposed legislation for the same reasons that Mr. Dobilas noted. He also said that such a model should not be discouraged in the interest of encouraging competition and thus industry innovation.
Mr. Schacht supported the proposed legislation generally, but was concerned about the detail in the proposed legislation. Instead, he encouraged “a reworking of [the proposed legislation] that identifies and sets objectives, and imbues the functional regulatory agency with authority to implement the details of those objectives.”