SEC Rule 17g-5 is Stifling Deal Discussions

August 20, 2011 by · Leave a Comment
Filed under: Bond Regulation, General 

The Securities and Exchange Commission’s Rule 17g-5 was intended to introduce greater transparency and discourage credit ratings shopping. In practice it has made raters and issuers nervous to speak openly.

The rule requires that credit rating agencies share confidential loan-level arranger-provided information with other rating agencies on a password-protected website. Likewise, any verbal conversations, including phone calls and texts, must be recorded and documented on the website.

Rui Pereira, head of U.S. residential mortgage-backed securities at Fitch is quoted by Reuters as saying, “People are so concerned about litigation and risks that the operational review and ratings process has become a lot more complicated…Any questions about a deal must be e-mailed, and sent ahead of time.”

Another senior analyst from a different rating agency told Reuters , “Communication is ridiculous…I call an issuer with a question and he says, ‘I can’t answer that. E-mail that question to me and I’ll get back to you.’ It was so easy in the past. You just get on the phone to discuss it. With 17g-5, you eventually get the information you want, but it takes the longest way to get there.”

Although the rule’s purpose was to promote an equitable flow of information and motivate unsolicited ratings, it hasn’t worked. Since the rule went into effect, no rating agencies have issued an unsolicited rating.

Efforts Made To Delay Ban on Ratings in Rules

March 21, 2011 by · Leave a Comment
Filed under: Bond Regulation, The Rating Agencies 

Until a better alternative can be developed, banks and regulators are pushing Congress to rethink the ban on using ratings agencies’ assessments in regulations used to oversee banks.

They say the ban is too much too soon and forces regulators to rely on untested tools when assessing banks’ viability. Specifically, the worry is that banks may avoid holding public and private debt because of the work involved in demonstrating to regulators that those investments are at a low risk.

Barbara Roper, director of investor protection at the Consumer Federation of America and a leading advocate for tough financial reforms, is quoted by Reuters as saying, “This one, I just think in the heat of the moment, they didn’t think it through.”

It may be difficult for regulators to moderate the ban or to convince lawmakers that it needs to be narrowed. The ban was one of the few aspects of the Dodd- Frank reform law that enjoyed bipartisan support.

Regulators have until July 2011 to identify credit rating agencies references in their rules and to develop alternatives.

IMF Wants Rating Agencies Regulated

March 16, 2011 by · Leave a Comment
Filed under: Bond Regulation, IMF 

The International Monetary Fund (IMF) has come out in favor of increased regulation of the rating agencies. Their decision was made public in a report and was in reaction to the recent escalation of European sovereign credit risk. The IMF’s opinion was directed specifically at Moody’s, Fitch, and Standard & Poor’s, the only three agencies with a worldwide presence.

“In general, ratings are fairly accurate in foretelling when a sovereign is likely to default, though more attention to sovereign debt composition and contingent liabilities could help improve their rating,” said the IMF.

However the report complained that, “Ratings are embedded in various rules, regulations and triggers, so that downgrades can lead to destabilizing knock-on and spillover effects in financial markets.” A downgrade can lead to a sell-off that drives down the value of the affected country’s bonds, increases the cost of borrowing in the future, and imposes strain on government’s finances.

IMF recommended that policymakers should “wherever possible remove or replace references to ratings in laws and regulations, and in central bank collateral policies.”

Comment Period for Changes to Regulation AB Passes

February 11, 2011 by · Leave a Comment
Filed under: Bond Regulation, SEC 

In May, in an effort to bring trust and greater activity back to the asset-backed securities market, the Security and Exchange Commission (SEC) proposed significant changes to Regulation AB. This regulation dictates what information issuers of asset-back securities must provide to investors in prospectuses. The SEC intends to tighten the rules and the comment period on those changes has now passed.

Issuers of asset-backed securities will no long be able to file a “shelf registration” that they can use again and again to issue bundled securities with no clear disclosure of what is inside. Second, sellers must give investors time to assess the value of these complex securities before they can offer them for sale. And third, independent parties will be required to monitor these asset-backed securities to ensure they are performing as anticipated.

By requiring so much new information, the SEC is reducing the role of ratings agencies and urging investors to do more of their own analysis. The New York Times quoted the reaction that Ann Rutledge had to the rule changes. Ms. Rutledge is the co-founder of R & R Consulting, a structured credit analytics firm in New York. “My reading of this proposed ruling is it’s a very practical way of closing loopholes,” said Ms. Rutledge. “The regulators are now beginning to understand why they put the rules on the books and how the market worked around them.”

Administration Takes Special Aim at Rating Agencies

September 24, 2010 by · Leave a Comment
Filed under: Bond Regulation, Financial Reform, The Rating Agencies 

Deputy Treasury Secretary Neal Wolin has stated that the administration is advocating for several items in the House-Senate conference on the financial regulatory reform bill that don’t necessarily have substantial agreement, including “inclusion of the strong rules on conflicts of interest and transparency at credit rating agencies.”

“Financial reform is complex,” he said. “The details matter. And so, as conferees begin the process of reconciling the remaining differences in the two bills, we will continue to fight for the strongest financial reform bill possible. And we will oppose any attempts by particular interests to use the conference process as an opportunity to weaken the final bill.”

Yeah, sure…

LeMieux Amendment Would End NRSRO Designation

September 22, 2010 by · Leave a Comment
Filed under: Bond Regulation, FDIC, The Rating Agencies 

The financial regulatory reform bill that was passed by the Senate includes an amendment intended to “make banks, mutual funds and regulators do their own financial homework.” Sponsored by Senator George S. LeMieux (R-FL), the LeMieux-Cantwell provision was approved by a 61 to 38 vote.

It requires regulators such as the Federal Deposit Insurance Corporation to develop their own standards of creditworthiness instead of depending exclusively on credit rating agencies’ assessments. What’s more, the Lemieux-Cantwell amendment would eliminate the preference for ratings issued by a “nationally recognized statistical rating organization” (NRSRO) by removing references to it in regulations. Mr. LeMieux says these federal endorsements have created “a government-sponsored monopoly.”

This echoes Barney Frank’s language in the House bill. If rating agencies are so corrupt, and the ratings so wrong, let’s de-certify them and let investors do their own homework. If you can’t measure credit, you shouldn’t be in the game.

Senate Passes Historical Financial Overhaul Bill

September 15, 2010 by · Leave a Comment
Filed under: Bond Regulation, Financial Crisis, The Rating Agencies 

The biggest overhaul of U.S. financial regulations since the Great Depression was passed by the Senate in a 59-39 vote. The legislation addresses the regulatory gaps and speculative trading practices that are believed to have contributed to the 2008 financial market crisis.

One of the provisions in the bill establishes a new regulatory body for credit rating agencies. The self-regulatory organization will assign credit-rating agencies to provide initial credit ratings of financial packages. The measure is aimed at preventing institutions from shopping for the best rating.

The Senate bill must now be reconciled with the House version.  It is projected that these negotiations will be completed in the upcoming weeks and that the bill will be available for the President’s signature before the Fourth of July holiday.

Amendment to Add Create Rating Board Passes

The Senate has approved an amendment to its financial regulatory reform bill that authorizes the Securities and Exchange Commission to create a new credit rating board that would assign a credit rating agency to companies seeking an “initial rating.”

The proposal would only affect “structured securities,” which are mortgage-backed bonds, asset-backed securities, and other debt-like instruments that declined in value during the financial crisis.

Standard & Poor’s spokesperson Edward Sweeney criticized the amendment for the deleterious effect he said it would have on credit rating agencies’ “incentive to compete with one another, pursue innovation, and improve their models, criteria, and methodologies.”

The provision, proposed by Senator Al Franken (D-MN), passed by 64 to 35, which means it is likely to remain part of the final bill.

Financial expert, market technician and capital market participant Al Franken solves the conflict issue. This is a stupid idea. Is there ever a problem that can’t be solved by “more government”?

New Amendment Targets Rating Agencies

September 1, 2010 by · Leave a Comment
Filed under: Bond Regulation, The Rating Agencies 

Senators Al Franken (D-MN), Charles Schumer (D-NY), Bill Nelson (D-FL) and Roger Wicker (R-MS) have proposed an amendment to dismantle the “issuer pays” model that rating agencies currently use. The amendment would establish a Credit Rating Agency Board that would arbitrarily choose which rating agency would rate an issuer’s debt.

Taking aim at what they call a “permanent conflict of interest,” proponents of the amendment argue that this would make it more impartial as well as open up competition to smaller firms. The bipartisan proposal has received widespread support, including the endorsement of the Consumers Union consumer advocate group.

The rating agencies have unanimously come out against the amendment. “We believe the benefits of the issuer-paid model, combined with appropriate regulation, can far outweigh any potential conflicts of interest,” said Standard & Poor’s spokesman Ed Sweeney.

This is a bad idea (how come every problem can be solved with more government?). The only guys in America who didn’t know or understand this conflict existed were Franken, Schumer, Wicker, and Nelson. The new Board name should be aligned with the usefulness of the idea: Credit Rating Agency Panel.

The Effects of Reform

So, after protecting ratings as a First Amendment opinion, Congress changed the 2300-page regulatory reform bill and exposed the raters to legal liability if the ratings don’t reflect an ultimate change in the price of the bonds, or a default (crank up the class action lawsuit machine…).

What does this mean? Can a bond holder sue an NRSRO if the market value of a bond declines after a downgrade?

It means that this chills the value of a rating, if it exposes the rater to monetary liability. It seems there is a loophole, however.

If the rating was not part of the submitted OS or documents submitted to the SEC, the rating would be legally exempted, since it was not officially part of the submitted deal documents.

This is a stupid, populist nod to the worst of Congressional impulses. AT BEST, it will raise the cost of credit, and make it less available. AT WORST, it will put lawyers in charge of credit allocation.

What’s next, broker/ dealer stock buy and sell ratings? Will realtors be subject to legal liability if a house depreciates after you buy it? Will Las Vegas odds makers be subject to legal action if the odds are wrong and you don’t win?

The only good news is municipal bonds would be exempt because they do not have to register with the SEC. 

Bond Sale? Don’t Quote Us, Request Credit FirmsWSJ.com, July 21, 2010

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