April 15, 2009 / 9:33 PM / 8 years ago

SEC explores further credit rating reforms

WASHINGTON (Reuters) - Top U.S. securities regulators questioned Wall Street’s reliance on credit ratings and weighed changes for the industry, which has been blamed for contributing to the financial crisis.

At a day-long meeting on Wednesday, the Securities and Exchange Commission asked credit agencies, academics and investors about a range of issues such as how to boost competition among raters and whether a new business model for credit agencies was needed.

SEC Chairman Mary Schapiro asked whether government agencies and the SEC should continue to require reliance on credit ratings, an issue that divided the rating industry.

The SEC already has a pending proposal to wean Wall Street and investors off ratings. But the mutual fund and brokerage industry oppose the proposal, saying ratings give investors faith in the funds and create standards for assessing credit risks.

At Wednesday’s meeting, credit rating agencies provided a mixed response.

“To have less reliance on ratings is probably good,” said Daniel Curry, the president of DBRS Ltd.

But Curry said it was important to do this gradually to allow market participants to adjust to ratings being withdrawn from federal rules.

Realpoint LLC Chief Executive Robert Dobilas and Egan-Jones Ratings Company co-founder Sean Egan favored having references to ratings in federal rules. Fitch Ratings President Stephen Joynt said there was value in having credit ratings used by regulators and others as ‘benchmarks,’ but said ratings should not be the only thing they relied on.

SEC EXAMINES OTHER MODELS

The three largest rating agencies, Moody’s Corp (MCO.N), McGraw-Hill Cos Inc’s MHP.N, Standard & Poor’s and Fimlac SA’s LBCP.PA Fitch Ratings, have been blasted for assigning top ratings to mortgage-backed securities that later dropped in value when the housing market collapsed.

But an investor group, the CFA Institute, said credit rating agencies were not solely to blame.

“Investors and users have to fess up as well,” said CFA Institute managing director Kurt Schacht. “Credit ratings, in terms of structured products were misused by lots of investors ... We need to break this blind reliance (on ratings).”

The SEC has already adopted rules to crack down on conflicts of interests at rating agencies that are paid by the issuers and banks whose products they rate, referred to as the issuer-paid model.

For example, one rule would prohibit credit agency employees who help determine a credit rating from negotiating any fees.

However, Schapiro said: “There is still more to do. The status quo just isn’t good enough.”

A so-called subscriber-based business model, where investors or subscribers pay for the rating, is used by smaller rating agencies such as Egan-Jones Ratings Co.

Other SEC commissioners have suggested creating a revenue pool to pay credit raters -- a model most credit rating agencies oppose.

“Quality would suffer,” if random rating agencies rated products, Realpoint’s Dobilas said.

One suggestion by former SEC Commissioner Joseph Grundfest generated interest among the current commissioners.

Grundfest suggested creating a new category of credit rating agencies that were owned and operated by the largest and most sophisticated debt market investors.

“Because (those credit raters) would be controlled by the investor community they would have powerful incentives to issue prudent, even skeptical ratings,” said Grundfest, now a professor at Stanford Law School.

Under Grundfest’s proposal, every rating by an issuer-paid agency such as Moody’s would be accompanied by this other investor-owned rating, that was also paid for by the bank or issuer.

Lawmakers have been incensed with what they say was a lack of accountability and due diligence. Democratic Senator Jack Reed has drafted legislation that would allow investors to sue credit rating agencies if they failed to “conduct a reasonable investigation” of a rated security.

Reed’s bill, which has not been introduced and is still subject to changes, would also require the SEC to establish an office to coordinate activities for regulating credit rating agencies.

Reporting by Rachelle Younglai; Editing by Tim Dobbyn and Andre Grenon

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