FINRA Investigating Bond Underwriters

August 30, 2011 by · Leave a Comment
Filed under: The Ratings System 

Unnamed agencies and underwriters are being investigated by the Financial Industry Regulatory Authority (FINRA) to see whether the firms had been entertaining rating agency executives lavishly in an attempt to influence security ratings.

Reuters quotes FINRA Chief Executive Richard Ketchum from the annual FINRA fixed-income conference in New York as saying, “We have seen examples of excessive expenses for the entertainment of issuer officials and rating agency officials, which are then charged to the municipalities’ cost of issuance, thereby reimbursing the firm out of bond proceeds.”

Mr. Ketchum explained that this is part of an ongoing effort by Wall Street to self-police and ensure new issue pricing practices and fees are fair.

Reuters reports that the FINRA investigation has also discovered payments to political action committees as a line-item in new bond underwriting expenses. False representations of payments made to dealers and others for services never performed were also uncovered.

“These issues raise serious noncompliance issues and a breach of ethics that we are continuing to investigate,” Ketchum said.

Bahrain Reacts to Downgrade

The recent political unrest in Bahrain led Moody’s Investors Service to downgrade their sovereign debt on fears about the country’s domestic problems.

Bahrain central bank governor Rasheed Mohammed Al Maraj told CNBC, “I think the credit rating agencies took a hasty decision in terms of basing their decision on the political situation.” Al Maraj explained, “The economic fundamentals of Bahrain have not changed, as a matter of fact the public finance of Bahrain has slightly improved as a result of higher oil prices…Investors need to distinguish between the countries in the Middle East, as their dynamics are different.” He added that Bahrain had not experienced any negative impact from the region’s situation.

Unlike its neighbors, Bahrain does not have significant oil wealth and is not a member of OPEC. However, Bahrain has emerged as a Middle East banking capitol. This also causes Moody’s concern. Total bank assets are about 11 times Bahrain’s national income. Moody’s notes that, “potential liabilities stemming from the banking sector in a systemic crisis could…present a significant challenge to the authorities.”

CDS Market to Measure Creditworthiness?

August 18, 2011 by · Leave a Comment
Filed under: The Ratings System 

William Mast, writing for Hemscott, explored the possibility of replacing rating agency evaluations with credit-default-swap (CDS) market pricing to predict creditworthiness. He suggested that CDS pricing was a more fluid, market-driven metric to gauge the health of an issuer.

He explains that one of the main criticisms of the rating agencies is that their view is limited to the historical analysis from a single point-in-time. A better model for measuring creditworthiness would be to use real-time information.

Mr. Mast writes, “Despite some technical pressures and, at times, lack of liquidity, the CDS market nevertheless provides the purest independent measure of how the market perceives the prospects of a given entity. This raises a question: If appropriately harnessed and interpreted, can the signals provided by the CDS market improve investors’ ability to anticipate changes in an issuer’s creditworthiness? There’s a body of research that suggests the answer is yes.”

He admits that the public’s concern over a perceived lack of transparency and regulation in the CDS markets needs to be addressed before it can be a viable evaluator. However, he cites among other research findings how, “In 2008, Fitch Solutions used CDS pricing to build market-implied ratings and concluded thatthere is a clear ability to forecast future rating actions by examining CDS premiums.”

The lack of broad and deep CDS markets across all asset classes are also a limiting factor in their use.

SEC Eliminates Ratings Requirement

August 11, 2011 by · Leave a Comment
Filed under: SEC, The Ratings System 

In a 5-0 vote the Securities and Exchange Commission (SEC) proposed that key

documents intended to expedite the securities offering process no longer require a ratings reference. This action is part of broader initiative required by the Dodd-Frank financial reform law to eliminate ratings reference from all federal rules.

If the proposal is implemented, S-3 and F-3 “short form registration” documents that help to speed the offering process for selling securities “off the shelf” would no longer require that the company offering the bonds show the debt was given an investment-grade rating. Instead the SEC would require that the company be a “well-known, seasoned issuer.”

An SEC study suggests that if this regulation had been implemented between 2006 and 2008, 45 of about 1000 companies that issued debt securities would not have been eligible to use the expedited form.

EU Looks to Launch Rating Agency In Mid-2011

April 7, 2011 by · Leave a Comment
Filed under: The Rating Agencies, The Ratings System 

Michel Barnier, the European Union’s (EU) financial services commissioner announced at a press conference that they will create “a new [rating] agency, particularly with a European dimension” and “new ways of dealing with sovereign debt ratings by the middle of 2011.”

The European Council presented their plan at a recent meeting of EU finance ministers and central bank heads in Brussels. In a copy of the proposal secured by Bloomberg News, the council rationalized the initiative by saying that the “economic and political implications” of sovereign-debt ratings mean “it is particularly important that ratings of this asset class be accurate, timely and transparent.”

At the same meeting, ministers discussed rules to force rating companies to disclose reasons for changing a sovereign-debt rating. Following the meeting, Swedish Finance Minister Anders Borg also made clear that ministers were “ready to discuss” fines for ratings companies who mislead investors with poor quality ratings.

Academics Caution About Increased Rating Agency Competition

In the wake of the mortgage-backed securities debacle and other questionable business practices, regulators in the U.S. and particularly Europe are urging that the “big three” rating agencies face increased competition to drive better quality ratings. However, Bo Becker of Harvard Business School and Todd Milbourn from Washington University, warn that increased competition may not be a solution.

Analyzing Moody’s and Standard & Poor’s reaction to the rapid growth of the then-upstart Fitch in the early 1990s, the authors explain in Financial Times that, “The evidence we uncover appears unequivocally consistent with lower ratings quality as competition increased.” Specifically, as Fitch’s market share grew, the accuracy (measured as the correlation between ratings and bond yields) of a rating fell about one-third and the predictive power of default fell by two thirds.

The authors hypothesize that “…competition most likely weakens reputational incentives for providing quality in the rating industry, and thereby undermines quality. The reputational mechanism appears to work best at modest levels of competition.”

Standard & Poor’s Predicts Unsustainable Debt

March 25, 2011 by · Leave a Comment
Filed under: Financial Crisis, S&P, The Ratings System 

In a recently published report by Standard & Poor’s Ratings Services, “Global Aging 2010: An Irreversible Truth,” government debt of countries with advanced economies could reach over 300% of GDP within 40 years.

It is the opinion of Standard & Poor’s that the aging population could dramatically impact the prospects for economic growth while simultaneously facing greater budgetary pressures from increased age-related spending.

To counter this trend, the rising debt, and the negative impact on sovereign debt ratings, European governments have been attempting to make budgetary adjustments and to reform pension and health-care systems. These measures have been facing fierce union protests in France, Greece and most recently Italy.

In their press release, Standard & Poor’s quotes their own credit analyst Marko Mrsnik as saying, “No other force is likely to shape the future of national economic health, public finances, and national policies as the irreversible rate at which the world’s population is growing older. The projected deterioration in public finances between now and 2050 is particularly significant in advanced economies, whereas many emerging market sovereigns outside of Europe will have a slightly more positive trajectory. In these cases population aging is projected to take place against the background of relatively higher economic growth than in advanced sovereigns. However, as the emerging sovereigns develop, with associated widespread changes to the social fabric, government welfare spending may grow faster than GDP as has been the trend in advanced economies during the last half of the 20th century.”

EU Addresses Foreign Rating Agency Regulation

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

March 14, 2011 by · Leave a Comment
Filed under: The Rating Agencies, The Ratings System 

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.

The Next Best Thing

March 11, 2011 by · Leave a Comment
Filed under: The Ratings System 

It’s about time.

I’m glad someone else noticed that the NAIC has a workable solution. It might not be optimal, but it works.

(I would prefer to have the ratings fixed, rather than replaced).

See our posts starting 11/19/09.

[$$] No Ratings? No Problem –  American Banker, March 11, 2011.

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