Risk & Compliance

A Surge in Credit-Rating Firms?

Increasing competition, smaller rating services are expected to enter the market soon under the 2006 congressional reforms.
Alan RappeportJune 28, 2007

Seven credit-rating firms previously identified as nationally recognized statistical rating organizations (NRSRO) have formally registered with the Securities and Exchange Commission to comply with congressional reforms, and at least one more firm is in the process of registering.

The registering agencies are A.M. Best Co., Dominion Bond Rating Service, Fitch Inc., Japan Credit Rating Agency Ltd., Moody’s Investor Service, Rating and Investment Information Inc., and Standard and Poor’s Ratings Service.

The Credit Rating Agency Reform Act of 2006, signed into law last October, abolished the previous method the SEC used to designate NRSROs. But the commission still has oversight over the ratings services. And in May, the SEC voted unanimously to adopt rules increasing that oversight, with the aim of opening the market to more credit-rating competition. For one thing, the SEC boosted its authority to inspect rating agencies, although it has no say over their methodologies.

Before the law was passed, there were five NRSROs: Moody’s, Standard and Poor’s, and Fitch — which together control 80 percent of the market, a House committee affirmed last year — plus A.M. Best and Dominion Bond Rating Service. Dominion Bond Rating Service and Rating and Investment Information Inc. became NRSROs later.

In the past, the SEC identified an NRSRO through a “no-action letters” that acknowledged its credibility and national reach in issuing ratings. Under the Ratings Agency Act, to win SEC approval the service seeking treatment as an NRSRO must provide the commission with information that proves the credibility of the service, and that shows how it manages potential conflicts of interest.

More credit-rating agencies are expected follow the current seven in becoming NRSROs, including smaller firms that previously were excluded.

The Egan-Jones Ratings Co., based in Haverford, Pa., has applied for NRSRO status, and is waiting for a decision from the SEC. “We expect to be recognized shortly,” says Sean Egan, managing director of Egan-Jones. “The new act brings some clarity to the process. I think there’s a fair amount of frustration with the way things are being done currently, and this will bring some competition to the market.”

The act comes as ratings agencies have faced criticism for conflicts of interest and for their inability to foresee the crash in the subprime mortgage market. Since ratings agencies are often paid by the issuer that they rate, some question their ability to be objective.

The addition of smaller firms, such as Egan-Jones, could bring more transparency to a larger market.

“We are not paid by issuers,” says Sean Egan, whose firm has applied unsuccessfully for NRSRO status several times. “We aren’t smart enough to know how to manage that kind of conflict, so we steer clear of it completely.”