Capital Markets

Bill Would Boost Ranks of Credit Raters

In a move intended to open up a market long dominated by Standard and Poor's and Moody's, a House committee approved a bill that would eliminate th...
Stephen TaubJune 15, 2006

The House Committee on Financial Services has approved a bill intended to increase “competition, transparency, and accountability in the credit rating industry.”

The Credit Rating Agency Duopoly Relief Act of 2006, introduced last year by Rep. Michael Fitzpatrick (R-Pa.), was approved by voice vote on Wednesday and forwarded to the full House.

The committee noted of the more than 130 credit-rating agencies, the Securities and Exchange Commission has granted only five the designation of Nationally Recognized Statistical Rating Organizations (NRSROs): A.M. Best, Dominion Bond Rating Service, Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s. Moody’s and S&P control 80 percent of the market, the committee added.

If signed into law, the act would eliminate the SEC’s role in designating NRSROs. Instead, Reuters reported, credit-rating agencies that met certain standards would be able to register with the commission as “statistical rating organizations,” and the SEC would have no say in their rating methodologies.

“It is extremely disturbing that the two largest credit-rating agencies, Moody’s and S&P, rated Enron and WorldCom at investment grade just prior to their bankruptcy filings,” said Fitzpatrick, in a statement. “The lack of competition in the credit-rating industry has lowered the quality of ratings, inflated prices, stifled innovation, and allowed abusive industry practices and conflicts of interest to go unchecked.”

“This legislation will protect investors by ensuring that the ratings investors rely on reflect the true financial health of companies,” added committee chairman Michael Oxley, in a statement.

Specifically, according to the committee, the act would require each rating organization to disclose its long-term and short-term performance in rating securities and public companies; the methodologies it uses to derive ratings; conflicts raised by its business model; and how such conflicts are managed.

The committee added that the act would prohibit abusive industry practices such as sending a company unsolicited ratings with a bill; notching, which occurs when a firm lowers ratings on asset-backed securities unless the firm rates a substantial portion of the underlying assets; and tying ratings to the purchase of additional services.

In response to the House committee vote, the Association for Financial Professionals issued a press release calling the bill “a critical step” that would “foster competition, stimulate innovation and creativity, and improve the quality of information available to investors.”

Although credit-rating reform is also on the agenda of the Senate Banking Committee, according to Reuters no Senate bill is pending at this time.