Risk & Compliance

SEC Adopts Rating-agency Rules

The aim of the regulations is to open the credit-rating market to more competition.
Alan RappeportMay 23, 2007

The Securities and Exchange Commission voted unanimously on Wednesday to adopt rules that give it greater oversight of credit-rating agencies and aim to open the market to more competition.

The rules implement the Credit Rating Agency Reform Act of 2006, signed into law last October, which abolished the SEC’s authority to designate “nationally recognized statistical rating organizations.” At the time, there were just five NRSROs: Moody’s, Standard and Poor’s, and Fitch Ratings — which control 80 percent of the market, a House committee affirmed last year — plus A.M. Best and Dominion Bond Rating Service.

A sixth, Japan-based Rating and Investment Information, announced that on Monday the SEC had recognized it as an NRSRO — the first outside North America, although Fitch’s parent company is headquarter in France — in an action that predated the commission’s adoption of the new rules.

More credit-rating agencies will follow, but under the act, they are empowered simply to register with the SEC as “statistical ratings organizations,” provided they have three years of experience and meet certain other standards. The act also grants the SEC new authority to inspect rating agencies, although it would have no say over their methodologies.

The most controversial issue discussed by the commission concerned “notching” — when a firm lowers ratings on asset-backed securities because it doesn’t also have the business of rating a substantial portion of the underlying assets. The practice is often thought to be a way to stifle competition.

“Notching is a very difficult issue, and there is no easy answer,” Commissioner Kathleen Casey said on Wednesday. For the time being, the SEC will counter any possible increase in notching by calling greater attention to the issue. Commissioners also discussed logistics of agency registration with the SEC and ways to avoid potential conflicts of interest.

Last year’s bill drew some resistance from Standard and Poor’s, which argued that the new SEC oversight would infringe upon its rights to free speech. Rita Bolger, the rating agency’s general counsel, said at the time that it represented a licensing regime that “is not constitutionally viable.”

On Wednesday, Fitch issued a statement commending the work of the SEC for adopting rules that will foster greater “competition, transparency, and innovation,” in the ratings industry.