On Tuesday the SEC is holding a roundtable on credit ratings to address the ongoing question of ratings shopping. Rating shopping is when a bond issuer shops its deal to various credit rating agencies to see who will assign the highest rating. The rating agencies that will assign the best ratings are given the business and the rating fee. Here is how the SEC describes its event:
As previously announced, the roundtable will consist of three panels. The first panel will discuss the potential creation of a credit rating assignment system for asset-backed securities. The second panel will discuss the effectiveness of the SEC’s current system to encourage unsolicited ratings of asset-backed securities. The third panel will discuss other alternatives to the current issuer-pay business model in which the issuer selects and pays the firm it wants to provide credit ratings for its securities.
The possibility of a credit rating assignment system comes from legislation that Minnesota’s senator Al Franken inserted in Dodd-Frank. Franken’s law requires that the SEC study the feasibility of a bureau or panel that would assign a rating agency to rate an offering. Currently issuers choose which firms will rate their offering although for structured finance or asset-backed deals issuers must share the particulars of the new deal with all raters recognized by the SEC in that category. This is equivalent disclosure and something that I have advocated with the SEC since 2007 and Congress since 2008. It has slightly increased competition in rating structured finance securities as seen in the chart above although the size of the market has declined since 2007.
In theory the idea of a bureau that assigns rating agencies has much in it’s favor, but it goes against all the rest of the law related to credit ratings. Current law (Credit Rating Agency Reform Act of 2006) enshrines the principles of increasing transparency and competition for ratings. The Franken proposal moves in the opposite direction by narrowing the number of opinions on specific bond issue.
But maybe all of this is shooting in the wrong direction away from the real problems of rating asset-backed securities. Here is a comment from former Moody’s senior vice president William J Harrington made on a Financial Times story about the SEC Roundtable: