Efforts Made To Delay Ban on Ratings in Rules
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.
EU Addresses Foreign Rating Agency Regulation
Filed under: The Rating Agencies, The Ratings System, Uncategorized
The European Union (EU) regulators envision two ways to handle ratings from agencies that come from non-member states. The first is to accept ratings of countries that they believe are “equivalent,” such as Japan.
The second way to is to accept ratings from other countries so long as their process is as “stringent” as in the EU and an EU agency has endorsed the assessments.
If the latter is imposed in a strict sense, it could affect both borrowers and lenders from other countries looking to engage Europeans institutions. Banks in particular could have a hard time holding non-EU assets as regulated capital under the new law.
The Financial Times quotes a worried diplomat as saying, “European banks could be shut out of certain capital markets…it’s not a small issue.” The United Kingdom and the Netherlands among other Nordic states are urging a loose interpretation of the regulation whereas France and Italy are pushing for a strict application.
New Chinese Semi-Official Rating Agency
Chinese officials have been candid in expressing their opinion that the three major rating agencies, Standard & Poor’s, Moody’s and Fitch all had conflicts of interest that led them to assign top ratings to securities that later turned out to be junk.
To work around these agencies, China is establishing the China Credit Rating Company (CCRC) that will charge investors instead of issuers to assess investment risk.
It is intended that the CCRC be a not-for-profit organization, which will be funded by the National Association of Financial Market Institutional Investors (NAFMII), a trade group within the People’s Bank of China, China’s central bank.
Because the agency will be circumventing what they believe to be a fundamental conflict of interest that has plagued leading Western agencies, the Chinese believe the CCRC will have more credibility.
Liu Shiyu, a vice governor with China’s central bank, stressed the value of independent risk assessments. “The new firm is a tentative effort on this road,” Liu said. “But we also need to be aware that it will be a very difficult task to reform the ratings industry.”
The charging model for this new rating agency is still to be determined.
Rating Agencies Ignored Risk
Keith Johnson, the former president and chief operating officer of Clayton Holdings, testified before the Financial Crisis Inquiry Commission (FCIC) that Moody’s Investors Services, Standard & Poor’s and Fitch Ratings all ignored his company’s discovery that many mortgages that were being combined into securities during 2006 and 2007 were substandard.
Clayton reviewed more than 911,000 mortgages during 2006 and 2007 for large investment bankers who sold them as mortgage-backed securities.
Johnson told the FCIC that approximately 46% were “bad loans” based on unverified borrower information. He testified that, “We took this to the credit rating agencies and said, ‘Wouldn’t this information be great for you to have as you assign tranche levels of risk?’”
“While most said they loved it, none of them would have adopted it at that time. If anyone at that time had adopted they would have probably lost market share,” Johnson explained. “The issuers would have gone through the easier channel.”
India Considers Expanded Ratings Regulation
The Securities and Exchange Board of India (SEBI) is reviewing limitations on “rating shopping” by issuers of corporate bonds. Current Indian law allows a corporation to accept or reject a rating issued by a credit rating agency. The credit rating agency then keeps the rejected rating confidential.
The SEBI is worried that corporations are successfully hiding bad credit ratings and only using ratings that are favorable.
Under consideration is a requirement that credit rating agencies make all ratings public, even those evaluations rejected by the company. Other proposals include allowing credit ratings agencies to offer unsolicited ratings and asking corporations to be rated by two ore more agencies.
As in the United States, credit ratings agencies in India are hired by issuers. Regulators are also pushing for agencies to erect “firewalls” between the credit rating agencies business development teams and the debt analysts to minimize any risk of conflict of interest.
Moody’s Avoids Lawsuit
The Securities and Exchange Commission (SEC) announced that they were not going to file suit against Moody’s for fraud even though it had evidence that the firm had knowingly misled investors.
According to The Washington Post, Moody’s executives discovered they had provided ratings that were too optimistic but had chosen not to correct them because, “downgrades could negatively affect Moody’s reputation.”
The SEC explained that it did not file suit because of “jurisdictional” limitations; the activity occurred in Europe and was, at the time, outside the agency’s authority.
The agency did say, however, that the decision may have been different if the fraudulent activity had taken place after it was given the power by Congress to sue credit-rating firms engaged in “otherwise extraterritorial fraudulent misconduct” in the financial regulation overall legislation that was enacted this summer.
The SEC usually does not issue a report when it is not going forward with a suit, but The Washington Post clarifies that in this case, “…agency officials said they wanted to send a message in reviewing their findings in the Moody’s probe that credit-rating firms would face increased scrutiny.”
Berkshire Hathaway Holds Steady with Moody’s
Each quarter investors anxiously await Berkshire Hathaway’s 13F filing to see how Warren Buffett has adjusted his portfolio during the last three-month period. His transactions are treated by some as harbingers of what is to happen in the upcoming months.
The general reaction to the most recent filing was that Mr. Buffett is adapting a more conservative mindset. Notable among the transactions, however, was that the position that Berkshire Hathaway held in the rating agency Moody’s did not change. In past periods, Berkshire Hathaway and Warren Buffett were aggressive in cutting their investment in Moody’s.
No reason was provide for this change in investment strategy; however, some are speculating that Berkshire Hathaway has renewed confidence in this rating agency and possibly the entire rating agency segment. This is logical, since Dodd-Frank punted on rating agency reform.
French Unions Plan Pension Protest
To avoid the credit problems that have plagued Greece, Portugal, Italy and others in the European Union, France is taking steps to scale back its generous pension program.
The credit rating agency Moody’s recently noted that pension reform is critical to France trimming the public deficit so it falls within the 3%-of-GDP limit specified by euro zone treaties. To maintain its good credit ratings, the country needs to demonstrate that it can implement fundamental reforms to help reduce its public deficit.
Proposals that will go before France’s parliament in September include raising the minimum retirement age from 60 to 62 and increasing the age at which workers can retire with full benefits from 65 to 67.
French unions do not like the proposals and are taking steps to cause legislators to support their position. Seven unions are calling on members to stage a “day of massive strikes and demonstrations” on September 7th, the day Parliament will begin to discuss proposals. Unions claim that employees will unfairly bear the cost of pension reform.
A New Business Model Emerging for Ratings Agencies
The credit rating agency Realpoint is considering whether to begin offering unsolicited ratings. Their intention is to sell ratings and analysis on a fee basis to investors.
Daniel Indivigilo of The Atlantic believes that serious issues need to be resolved. First is whether investors will have an appetite for unsolicited ratings. Fund managers are supposed to be the expert. Hiring an outside agency could make them look bad.
Second, Mr. Indivigilo writes, the rating agencies, Realpoint included, have trouble keeping their best analysts. They are quickly lured away by investment banks and hedge funds that can offer better compensation. To pay these talented employees, a competitive wage may cause fees for unsolicited ratings to be unfeasible if the volume doesn’t materialize, particularly in situations where the issuer is offering his or her own assessment at no cost.
Mr. Indivigilo concludes by saying that in theory unsolicited ratings are “a great thing to provide more perspective on the market and various securities,” but he cautions that “a bumpy road lies ahead.” This is how it is supposed to work. Let’s let the capital markets figure out the best architecture for rating investments. Government-imposed structure won’t be optimal.
China, Chinese Rating Agency Send Mixed Signals
Beijing-based Dagong Global Credit Rating has determined that China’s creditworthiness is superior to the U.S.’s. Dagong, founded in 1994, had until recently only rated Asian corporate debt. This is their first attempt to evaluate sovereign debt.
Guan Jianzhong, chairman and president of Dagong, had harsh words about the U.S. during an interview with the Financial Times: “The U.S. is insolvent and faces bankruptcy as a pure debtor nation but the rating agencies [The Big Three] still give it high rankings.”
Many share Mr. Guan’s skepticism of the U.S.’s creditworthiness, and some in Asia have received Dagong’s ratings with enthusiasm.
U.S. Treasury Department statistics report that between 2004 and last year, China extended its holdings of U.S. securities 400% to more than $1.4 trillion.
Dagong has applied to the Securities and Exchange Commission to become a nationally recognized agency in the U.S.
