As part of its broader examination of the impact of credit ratings agencies on the financial markets, the Securities and Exchange Commission (SEC) has published a new request for comment on the feasibility of a system in which a public or private utility or a self-regulatory organisation would assign a nationally recognised statistical rating organisation (NRSRO) to determine credit ratings for structured finance products. The regulator is seeking to determine whether such a utility approach (a popular theme throughout Dodd Frank – see the Office of Financial Research for another example) would eliminate conflicts of interest in the ratings assignment process.
Section 939F of the Dodd Frank Act directs the SEC to study the credit rating process for structured finance products and the conflicts associated with the “issuer pay” and the “subscriber pay” models. It also requires the regulator to study the feasibility of establishing a system in which a public or private utility or a self-regulatory organisation could assign NRSROs, of which there are currently 10 registered in the market, to determine the credit ratings for these products.
In addition, the study must address the range of metrics that could be used to determine the accuracy of credit ratings for structured finance products, and alternative means for compensating NRSROs that would create incentives for accurate credit ratings for these products. The regulator has been set a deadline of 21 July next year by which to submit the findings of the study to Congress along with any recommendations for regulatory or statutory changes that it determines should be made.
Accordingly, the regulator is asking interested parties to provide comments, proposals, data and analysis in response to questions presented in the request. The public comment period will remain open for 120 days following publication of the request in the Federal Register.
The issue of “moral hazard” related to the current method of assigning ratings to these products and the way in which firms pay for these services has been a much debated topic since the financial crisis. The big three agencies have come under intense scrutiny for the part they played in the crisis by assigning incorrect ratings to structured products. The regulator is keen to determine where any conflicts of interest currently lie and whether there is any empirical data on which to assess these conflicts, such as differences in the ratings for a particular instrument.
The SEC is therefore posing a number of questions to firms that use these ratings for instruments such as residential mortgage backed securities (RMBSs), commercial mortgage backed securities (CMBSs), collateralised debt obligations (CDOs), collateralised loan obligations (CLOs), or other asset backed securities (ABSs). It is also scrutinising the data collection phase of the process for determining and monitoring credit ratings for structured finance products, including: the types of data collected; the sources from which the data is obtained; whether, and, if so how, the data is validated; whether the data is public or non-public; and how, if at all, the data is captured in the NRSRO’s systems.
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