SIFMA today submitted comments to the Securities and Exchange Commission (SEC) in response to a Dodd-Frank mandated study the Commission must undertake related to the assignment of credit ratings to structured financial products.
Specifically, Section 939F of Dodd-Frank requires the Commission to study and develop rulemaking to establish a system related to the assignment of initial credit ratings on structured finance products by nationally recognized statistical rating organizations (NRSROs) that prevents the issuer from selecting the NRSRO that will determine initial credit ratings. If the SEC is unable to find a superior alternative, they are required to implement a regime that was found in the Senate’s version of the Dodd-Frank Act (the “15E(w) system”), but which was replaced with Section 939F in the final bill. In today’s letter, SIFMA strongly opposes the implementation of the 15E(w) system because it would represent an unprecedented intrusion of government control into a private financial market, and strongly supports the alternative proposed by the SEC that Rule 17g-5 satisfy the requirements of Section 939F. Rule 17g-5 provides transparency into the data and information used by a rating agency, allows other rating agencies to access and use that data and information as desired, and most importantly, allows market participants to discern whether or not conflicts of interest have influenced a rating.
The 15E(w) system would create a Credit Rating Agency Board that would, among other things, determine qualification standards for NRSRO’s deemed eligible to provide an initial rating, direct the flow of business to NRSROs by assigning them to transactions for which they would provide an initial rating, levy fees on NRSROs, review the performance of NRSROs, and limit the compensation of NRSROs who perform an initial rating.
“We believe the 15E(w) system would impose unprecedented government control on private markets,” said SIFMA executive vice president Randy Snook. “If implemented this regime would further entangle the government in credit ratings, running counter to the other parts of Dodd-Frank which compel regulators to disentangle government from credit ratings. This regime would also run the risk of significantly disrupting securitization markets which are essential to economic recovery, at great cost and limited benefit.”
The provision of Dodd-Frank was meant to address perceived conflict of interests in the current issuer-pays model of credit ratings. However, SIFMA believes that conflicts of interest will be present in any model for credit ratings, and will always need to be managed appropriately. SIFMA believes that the current rule 17g-5 addresses these issues today. Therefore, SIFMA examined the specific costs of a move to the 15E(w) approach. In its letter to the SEC, SIFMA raised significant concerns, including:
- The implementation of the 15E(w) system would represent an unprecedented intrusion of government control into a private financial market;
- Such government involvement runs directly contrary to the direction of other Dodd-Frank provisions, which calls for federal agencies to review their rules and remove references to credit ratings;
- The 15E(w) system presents its own set of conflicts of interest, such as incentives for rating agencies to lobby, or attempt to curry favor of particular Board members in order to obtain creased business, and the risk that political pressure would distort credit ratings;
- The quality of the expertise of the Board and its staff is in question, especially when the Commission’s request for comments does not include staffing or employment of Board members and regulators currently face significant funding challenges;
- 15E(w) also presumes that any issuer would be able to obtain, and an investor would value, a rating from any qualified NRSRO, which, in reality, is not always possible; and
- The 15E(w) approach would not represent an improvement over the current regime but would merely shift conflicts of interest to a different area while imposing significant costs and burdens on securitization markets.
- The SEC in its request for comments suggested a number of alternative approaches. Among these, SIFMA strongly supports the current Rule 17g-5 regime that deals with conflicts of interest, and better accomplishes the goals of 15E(w).
Rule 17g-5 creates transparency into the information provided to a rating agency hired by an issuer by requiring issuers to post it on website accessible to other NRSROs, and allows any other NRSRO to use this information to developing alternative credit ratings or commentary. 17g-5, therefore, allows market forces to operate to develop alternative forms of organization for NRSROs, such as user-paid or other models, if market participants so desire. SIFMA suggests modifications to the existing Rule 17g-5 to improve its effectiveness, and believes the rule is a far superior alternative to the 15E(w) approach. A link to SIFMA’s letter is available here: www.sifma.org/Comments-SEC-CreditRatingsStudy