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May 12, 2013 2:21 pm
The issuers of securities backed by mortgages, credit card debt and car finance could be forced to reveal more details about their structures and underlying loans, in an attempt by US regulators to limit so-called “ratings shopping”.
The Securities and Exchange Commission will debate on Tuesday whether wider disclosure would cut the risk of credit rating agencies giving inflated grades to risky securities in order to win business.
Improved transparency around asset-backed securities has emerged as a favoured alternative among rating agencies, issuers and investors to a more draconian measure inserted into the Dodd-Frank Wall Street reform law by Senator Al Franken. His plan would create a new board to assign one of a number of approved rating agencies to rate each new asset-backed securities deal, on a rotating basis.
Critics of Mr Franken’s plan say that it would create an expensive new bureaucracy, without eliminating the incentive for rating agencies to give generous ratings to win business on top of the work assigned by the board.
On Tuesday, an SEC roundtable with industry players and academics will debate the Franken plan and an alternative that would expand existing disclosure rules around asset-backed securities. Inflated ratings on residential mortgage-backed securities were seen as a contributor to the financial crisis.
“Anything you tell a rating agency, you ought to tell the rest of the world, pure and simple,” said Larry White, economics professor at New York University, who will be participating in the roundtable. “Part of the story of why the agencies flopped so badly with regard to RMBS is that there was no check of an outsider looking in.”
Issuers are already required to make detailed information about the structure of the deal and the underlying loans available to all rating agencies, including those that have not been hired to rate the deal. But restrictions on the use of that information have limited the number of unsolicited ratings issued by rating agencies.
Options under discussion include easing those restrictions to encourage agencies publicly to critique each other’s work – an option supported by the Structured Finance Industry Group – and throwing open the information to public view.
Moody’s and Standard & Poor’s, the two largest agencies, both support full publication of the data.
The SEC has been ordered to introduce the Franken plan unless it finds an alternative for dealing with the conflicts inherent in the rating agency business model, under which securities issuers choose and pay the firms that rate their products.
Jules Kroll, founder of Kroll Bond Ratings, a smaller rating agency, plans to argue in favour of rotating agencies in order to break the “oligopoly” of Moody’s and S&P, but through a simpler mechanism than that proposed by Senator Franken. “And why limit it to structured finance?” he said. “Why not extend it to municipal and corporate bonds?”
Tom Deutsch, executive director of the American Securitisation Forum, said that ratings shopping can be curbed if investors know when and why rating agencies disagree on the merits of a particular security.
“You want them to compete against each other on intellectual content. That is better than the whackadoodle idea of having the government in the business of deciding which agency will rate a deal.”
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