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sec, risk determinations, and credit ratings July 1, 2008

Posted by Bradley in : Uncategorized , trackback

The SEC has now published the details of three sets of proposals relating to the use of credit ratings (here, here, and here), saying:

The proposed amendments are designed to address concerns that the reference to NRSRO ratings in Commission rules may have contributed to an undue reliance on NRSRO ratings by market participants.

These proposals supplement earlier proposals for “reducing conflicts of interest in the credit rating process, fostering competition and comparability among credit rating agencies, and increasing transparency of the credit rating process” and improving investors’ understanding of credit ratings. A number of the proposed changes involve making it clear that the burden for making credit risk determinations falls on Boards (although they may choose to rely on ratings from credit rating agencies (NRSROs)). Investment advisers would also be required to make their own determinations of credit risk and would be prohibited from relying exclusively on ratings. Other proposals relate to securities issuance. For example, the SEC proposes to limit short form shelf registration for asset backed securities so that only issues to large sophisticated and experienced investors would be eligible. Brokers will no longer be required to inform customers that a security is unrated:

in proposing to no longer require broker-dealers to include in transaction confirmations the information that a debt security is unrated, we do not mean to suggest that information about an issuer’s creditworthiness is not a relevant subject for discussion and consideration prior to purchasing a debt security. We would encourage investors to seek to understand all of the risks of securities, including credit-related risks, before buying. In addition, we note that deleting this requirement would not prevent broker-dealers from voluntarily continuing to include this information in transaction confirmations.

In its discussions of these proposals the SEC is very focused on the problem that including ratings in its rules involves putting the Commission’s seal of approval on the ratings. But by recognising certain entities as NRSROs, surely there is something of a seal of approval anyway? The SEC doesn’t do merit reviews of securities offerings, but the decision whether or not to register a rating agency as n NRSRO (or an exchange, or a broker dealer) is a merit review process. Under the Credit Rating Agency Reform Act of 2006 the SEC is to register an NRSRO “unless the Commission finds (in which case the Commission shall deny such registration) that- ‘‘(I) the applicant does not have adequate financial and managerial resources to consistently produce credit ratings with integrity…” And it is a bit odd (not to say backwards) that at a time when NRSROs were less regulated they benefited from this imprimatur, but as they are being subjected to ostensibly more stringent regulation (there’s some debate on this point) they don’t.

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