How the SEC seems set to fix the ratings impasse

By Felix Salmon
July 23, 2010
declared earlier this afternoon that "repealing AB1120, if only temporarily while the SEC works out some kind of sensible permanent solution, seems to be the obvious way to go", the SEC has gone and done exactly that:

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Wow, it seems I was actually right for a change! After I declared earlier this afternoon that “repealing AB1120, if only temporarily while the SEC works out some kind of sensible permanent solution, seems to be the obvious way to go”, the SEC has gone and done exactly that:

Within the next day, the Division of Corporation Finance expects to issue a ‘no action’ letter allowing issuers for a period of 6 months to omit credit ratings from registration statements filed under Regulation AB.

As  Stacy-Marie Ishmael notes, however, this looks very much like the regulatory equivalent of avoiding the pain of paying for something in cash by putting it on a credit card instead; she quotes RBS strategist Paul Jablansky as saying that “at the end of the six-month period, market participants will be faced with the same concerns that froze the market this week”.

I do think that Stacy is a bit too quick to discount the 144a option, though. If you do a private bond sale, rather than a public one, then the SEC rules are loosened a little and the ratings problem goes away. There are two downsides, as explained by BofAML:

Many investors cannot participate in the 144a market, so we do not think that market provides a long-term solution…

A shift to the 144a market has the potential of increasing funding costs to issuers and consequently consumers. Instead of seeing their funding costs rise, some issuers may reduce origination volumes.

I’m not so convinced. I’ve seen big bond deals done in the 144a market in the past and if the structured-credit world just moves en masse over to the 144a market, it won’t take all that long for investors to follow it. The kind of people who buy structured products can normally get certification to buy 144a deals if they put their mind to it.

And the language about “increasing funding costs to issuers and consequently consumers” is a dead giveaway that the note is part of a political lobbying effort, rather than anything particularly objective: consumers of what, exactly? Whenever there’s a potential market development that the banks don’t like, their knees jerk and they start talking about “increased costs to consumers” even when doing so makes little if any sense.

The fact is that if the whole market goes semi-private and takes place under the auspices of Rule 144a, very little will change. It’ll be the same issuers and the same investors and the same intermediaries. It’ll even be the same lawyers. There might be a bit of a bumpy transition, but that’s what these six months are for. So get cracking, buy-side investors without 144a access, and start applying for it now!

As for my original question of how the SEC will cope with the problem, I think that if the market moves to 144a, that’s as good a solution as can be expected. The SEC gets to look tough, the ratings agencies don’t take on liability they don’t want and no one messes with Congress’s legislation. I wouldn’t go so far as to call it elegant, exactly, but I don’t think it will annoy anybody too much.


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If you thought securitization was a clubby world ripe for manipulation before the crash, just wait until it goes private and no-one has to file those lovely prospectuses that Michael Burry could get on 10k wizard for $100 per year. You can get the odd deal done in the 144A market, but it will act as a limiter on the volume of deals that an issuer can get done. You might see that as a feature rather than a bug, however.

Posted by gringcorp | Report as abusive

I do not think it could matter. Retail investors do not have access to ABS. Surely that market will be able to come up with its own disclosure. The best it will do is unemploy some corporate lawyers and let the SEC move on to other things.

Still, GM announced a plan to buy AmeriCredit yesterday.

I am guessing in reality there is not much concern about this issue.

Posted by itserich | Report as abusive

144a will not be able to handle even the reduced post-2008 volume of SF deals. Increasing incentives for accuracy through threat of litigation was the purpose of this legislation, and it will likely have the effect of reducing the volume of deals, or making them marginally more expensive (which might price some people out of the market).

This, I argue, is a good thing, because the deals that are left will in theory be more reliable (because the ratings behind them are more accurate). Less available credit that is more reliable and stable is the whole point of reform. I think those crying about contracting credit availability and more expensive financing do not yet fully understand the degree to which risk was underpriced in the last decade.

Posted by shrivti1 | Report as abusive

Any chance the rule change will be permanent? That would likely mean that ratings-agency business will disappear, at least in its current form. But since the consensus seems to be that the ratings had become unreliable or even meaningless, that’s what one would expect anyway.

Posted by KenInIL | Report as abusive