Chinese Look To Develop Investor-Paid Rating Agency
The National Association of Financial Market Institutional Investors (NAFMII) is a Chinese self-regulatory organization set up by China’s central bank in 2007. It is now spending 50 million yuan ($7.5 million) to develop a new rating agency to help protect investors as private companies sell more debt.
Central to the establishment of the new rating agency is an investor-paid business model. China’s bond market regulator said that investors must fund the agency instead of issuers to avoid conflicts of interest.
Bloomberg News quotes Shi Wenchao, secretary-general of the NAFMII, as saying, “The credibility of China’s credit-ratings agencies and their authority is not high…The inadequate set-up of the industry in China has imposed no effective external constraints, and has caused some misbehavior in the market.”
China currently has five credit-rating firms all using an issuer-paid business model.
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.
IMF Wants Rating Agencies Regulated
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.”
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.
The Next Best Thing
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.
EU Considering Ratings Agency Fines
Finance ministers from the European Union (EU) are considering penalties for ratings agencies that assess members’ sovereign debt inappropriately harshly.
Didier Reynders, Belgium’s finance minister, said, “It must be possible to penalize, if after some weeks or months it is possible to say it [a downgrade] was a wrong signal, what is the responsibility of the rating agency? It is quite difficult to say that there is no responsibility if it is possible to prove it was a wrong analysis, a wrong signal. The penalties are the capacity to impose some responsibility on the rating agencies.”
There is an increasing level of frustration with the rating agencies among the EU nations. The general feeling is that ratings agencies are outside the area of reasonable responsibility and their opinions do not encompass all the factors that help to mitigate sovereign debt risk. Yet a seemingly arbitrary downgrade can have devastating effects on nations’ cost to borrow and consequently their national budgets.
How to determine whether agency rating was “wrong” and the appropriate penalties are still open questions.
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.
Comment Period for Changes to Regulation AB Passes
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.”
