Are Rating Agencies Forever Broken?

The group that helped lawmakers write the Credit Rating Agency Reform Act says the law isn't being enforced — and worries that even better enforcement might not be enough to rebuild market confidence in ratings.

So far, however, the SEC has been mum about its findings. To be fair, the SEC has had little time to act, notes spokesman John Nester. The SEC adopted its own Reform Act-related regulations last June, as required by Congress, and then had a few months to designate the NRSROs, which it did by the fall.

Still, full enforcement of the law will likely not satisfy all the raters’ critics. “They wish government edict would make the credit rating agencies smarter and faster,” former SEC commissioner Annette Nazareth told last fall before she resigned. “The Credit Rating Agency Reform Act does not address that nor should it.”

At the time, she said the SEC was in the process of building its resources to be able to handle its new authority. SEC spokesman Nester said he could not specify how many SEC staffers are dedicated to inspections of the agencies.

Cox has said the SEC plans to issue a formal report about the inspections in early summer. The commission may also propose this spring that agencies disclose information about past ratings so their users can judge the accuracy of each agency’s determinations over time. The commission will also consider whether it should require the agencies to make a distinction between ratings for corporate debt and structured debt, and may revise its own rules that require investors to rely on NRSROs.

But for now, any changes in response to the criticism lobbed against the agencies have been voluntary. For example, S&P and Moody’s are considering whether to distinguish between corporate ratings and ratings of structured securities.

At the same time, international regulators are asking the agencies to make changes to their code of conduct. Among the most significant recommendation to come from overseas is the idea that agencies should refuse to design structured products that they will later rate. Critics including Kaitz have pointed to this practice as one of the main conflicts of interest when it comes to ratings of structured products. In a similar vein, it has long been considered an inherent conflict that credit rating agencies make most of their revenue from the organizations they rate.

The International Organization of Securities Commissions — of which the SEC is a member — noted these conflicts in a report issued Wednesday that proposes revisions to its code of conduct for the agencies, which is voluntary. “While some observers believe the structured finance rating process does not necessarily pose an inherent conflict of interest vis-à-vis the CRA’s rating business more generally, the further question is whether a CRA has sufficient controls in place to minimize the likelihood that conflicts of interest will arise,” the report said. The contributors to the report included two SEC staffers who work in the Office of International Affairs.

If the SEC doesn’t quickly move forward with reforms, what’s left of the ratings’ credibility will continue to fall apart, Kaitz predicts. That credibility, he adds, is crucial for keeping the global capital markets in a healthy condition. “We’re clearly in a quandary here,” he says. “I don’t think the reputational risk of the rating agencies is going to just miraculously change overnight.”


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