Today, as part of the Obama Administration's continued push for financial regulatory reform, Treasury delivered proposed legislation to Congress to "increase transparency, tighten oversight, and reduce reliance on credit rating agencies" and "work to reduce conflicts of interest at credit rating agencies while strengthening the Securities and Exchange Commission's (SEC) authority over and supervision of rating agencies." The proposed legislation stems from "investors over reliance on credit rating agencies that often failed to accurately describe the risk of rated products."

The proposed legislation specifically addresses several issues the industry has expressed concern over during the recent economic crisis, in particular:

Conflicts of Interest

  • Barring firms from consulting with any company they also rate;
  • Prohibiting or requiring the management and disclosure of conflicts arising from the way a rating agency is paid, its business relationships and affiliations;
  • Disclosing the fees paid by an issuer for a particular rating, as well as the total amount of fees paid by the issuer to the rating agency in the previous two years;
  • Requiring a rating agency to conduct a review of ratings for a particular issuer, in the event an issuer hires an employee previously employed by the rating agency and who worked on the ratings for that issuer; and
  • Requiring each rating agency to designate a compliance officer, reporting directly to the board or the senior officer of the firm, with direct responsibility over compliance with internal controls and processes. The compliance officer will not be allowed to engage in any rating activities, marketing, sales, or setting of compensation; and will be required to submit a report annually to the SEC.

Transparency and Disclosure

  • Requiring an issuer to disclose all preliminary ratings it has received from different credit rating agencies in order to shed light on how much "shopping" an issuer has undertaken and whether there were discrepancies with the final rating;
  • Requiring rating agencies to use different symbols for structured finance products such as asset-backed securities, as opposed to standard corporate bonds, as an indication of disparate risks; and
  • Requiring that each rating also include a clear report containing assessments of data reliability, the probability of default, the estimated severity of loss in the event of default, and the sensitivity of a rating to changes in assumptions. This report will provide "a much fuller picture of the risks in any rated security through the addition of qualitative and quantitative disclosure of the risks and performance variance inherent in any given security."

Strengthen SEC Authority and Supervision

  • Establishing a dedicated office within the SEC to strengthen supervision of rating agencies;
  • Mandating registration for all credit rating agencies; and
  • Providing the SEC with the authority to examine the internal controls, due diligence, and implementation of rating methodologies for all credit rating agencies.

Treasury also anticipates working with the SEC and the President's Working Group on Financial Markets [] to "determine where references to ratings can be removed from regulations." Recently, the SEC requested public comment on whether to eliminate references to ratings in the regulation governing money market mutual funds, as a way to reduce reliance on ratings. Finally, the proposed legislation would require the General Accounting Office to study and issue a report on the reliance on ratings in federal and state regulations.