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SEC Deals Another Blow to the Ratings Agencies with Further Proposed Legislative Amendments

As part of its overall crackdown on the credit ratings agencies, the Securities and Exchange Commission (SEC) has this week proposed a series of amendments to the Securities Act of 1933 and the Investment Company Act of 1940 that will remove the requirements for mandatory credit ratings. The proposals are in accordance with the provisions of the Dodd Frank Act and propose to replace the ratings with new “standards of credit-worthiness”.

Since the financial crisis, the regulatory community has been keen to move away from a reliance on credit ratings, especially with regards to their mandatory use in the process of determining the credit-worthiness of money market funds and securities. Back in 2009, Paul Kanjorski, chairman of the House subcommittee on capital markets, recommended going one step further than the current proposals by making these agencies collectively liable for inaccuracies in their ratings.

The SEC’s recent proposals, however, do not go this far but stem from a review conducted by the regulator in 2008 in order to decide upon the best course of action to this end, and market participants have until 25 April to comment on these proposals. These proposals also follow on from earlier proposals issued by the SEC related to amendments to its rules that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale.

The SEC provides examples of how the removal of these particular references to credit ratings will impact the regulations overall. “We are proposing to remove references to credit ratings in rule 2a-7, which would affect five elements of the rule: determination of whether a security is an eligible security; determination of whether a security is a first tier security; credit quality standards for securities with a conditional demand feature; requirements for monitoring securities for ratings downgrades and other credit events; and stress testing,” states the regulator.

By taking the mandatory credit rating element out of the equation, firms will have to put in place new standards in order to determine factors such as the eligibility of securities. The details of the new standards for credit-worthiness make up the bulk of the comment paper and they include new data checks, limits and requirements by which securities must be judged. Credit risk evaluations will therefore need to be strengthened in order to take into account these changes and firms will need to ensure the data on which these judgements are made is of sufficiently high quality; yet another compelling argument for investment in data management solutions going forward.

Europe is taking a slightly different tack from the US with regards to ratings agencies and, earlier this year, the European Securities and Markets Authority (ESMA) released proposals to put in place a new reporting regime for ratings agencies to provide information on the historical performance of their credit ratings issued to the regulator, which would then be published in a central repository. ESMA will, from 1 July this year, assume responsibility for the supervision of the European ratings agencies and these firms will therefore need to register with the new European level regulator in order to conduct business in the region and for their ratings to be used for regulatory purposes.

However, some market participants are keen for similar moves to the SEC’s being taken in Europe. For example, issuer association EuropeanIssuers indicated back in 2009 that it wished for references to credit ratings to be completely removed from European legislation. “We therefore urge the European Commission to continue the work it started when consulting the market on this subject in July 2008, and to come forward soon with concrete proposals to eliminate references to credit ratings in the European legislation,” it said in a statement.

Both moves by the regulators are obviously a blow to the beleaguered credit ratings agencies, whose revenues have been hard hit already by the regulatory crackdown. Most are investing heavily in other aspects of their business such as data solutions and analytics in order to ensure that they are still standing when the dust settles.

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