WASHINGTON, Apr 15, 2009 (A. M. Best via COMTEX) -- MJP | Quote | Chart | News | PowerRating -- The U.S. Treasury's Troubled Asset Relief Program and Federal Reserve's Term Asset-Backed Lending Facility could be used to roll out a new model for rating the creditworthiness and financial strength of securities and issuing firms, an advocate for institutional investors told members of the U.S. Securities and Exchange Commission.

 

Appearing before an SEC panel on oversight of credit rating agencies, former Morgan Stanley global research director Mayree C. Clark, now a member of the investment committee of Aetos Capital Asia, proposed moving away from both the prevailing "issuer pays" model used by most rating agencies and the "investor pays" model used by Egan-Jones Ratings and in the process of implementation at Moody's Investor Service. Instead, Clark said, Nationally Recognized Statistical Rating Organizations should have incentive to rate new issuances and to publish their ratings, with investors determining which firm's research should be rewarded with fees.

Under Clark's proposal, which she called the "designation model," an issuer would provide information about itself and its securities to any rating agency interested in providing a rating. Fees for rating agencies that assert they are interested would be deducted from the proceeds of the issuance and placed in an escrowed pool. Allocations would be made from the pool determined by those investors that buy and own the securities in question, with designations made in proportion to the size of the investor's stake. Fees also would be paid for bonds' coupons and ultimately when the issue comes to maturity.

"We could start experimenting with this immediately. In the regulatory community today, we happen to have a few people quite influential in the new issue process, which is where you need to start," Clark said. "And so, via TARP and TALF, we could start working with this, just as soon as we decided it was the right thing to do."

Created in the early 1970s, NRSRO status is granted by the SEC to ratings agencies whose ratings are deemed to be "reliable and credible." NRSRO status allows a firm's ratings to be used when distinguishing levels of creditworthiness required under numerous federal and state laws. SEC Chairman Mary L. Schapiro said "although our statutory authority to regulate rating agencies has only been effective for less than two years, it is clearly one of this agency's most important responsibilities," noting several pending proposals to change how NRSROs may operate.

The SEC was given expanded oversight powers over NRSROs by 2006's Credit Rating Agency Reform Act. But that bill's co-author ? former House Financial Services Capital Markets Subcommittee Chairman Richard Baker, R-La. ? now believes the law did not do enough either to foster new competition in the rating agency market or to control conflicts of interest at the rating agencies. Baker, now president and chief executive officer of the Managed Funds Association, told the commission "we find ourselves grappling with the many of the same questions two years later."

Nonetheless, Baker urged only "modest changes" in how the rating agencies are regulated, proposing that the credit default swap market and the abundance of short-sellers of securities already act as real-time, "de facto rating agencies," by offering the market's current view of the creditworthiness of various securities. Instead, he suggested enhanced transparency of rating agency functions, such as the recently implemented requirement that NRSROs provide the SEC with annual "credit report cards" on the securities they rate.

"I would suggest examination of that disclosure material be broadened to enable a user to determine from a historic perspective the reliability of the particular rating agency's work over some prior period of time, whether 12 or 24 months," Baker said.

Glenn Reynolds, chief executive officer of the nine-year-old CreditSights Inc., said it remained too difficult for new firms to become designated NRSROs, despite the 2006 law. Only five credit rating agencies were designated as NRSROs at the time of the 2006 overhaul: A.M. Best Co., Standard & Poor's, Moody's, Fitch Ratings and Toronto-based Dominion Bond Rating Service Ltd. Those firms have since been joined by five more: Egan-Jones, Japan Credit Rating Agency Ltd., R&I Inc., LACE Financial and Realpoint LLC.

"If we wanted to have a business model that was viable in this market, making NRSRO status a priority made no sense. From our standpoint, the NRSRO business is plagued by a stacked regulatory deck, and that's still the case today. The way it's set up, a competitor cannot be a meaningful factor, except in a small subset of the asset classes," Reynolds said.

In addition to domestic changes to the rating agency business, the global regulatory community also demands change, according to Jörgen Holmquist, director-general for internal market and services at the European Commission. Holmquist noted the recent G-20 meetings included consensus that rating firms should be regulated by a nation's securities supervisors, who must be empowered to impose sanctions, including withdrawing a firm's license to operate, if it runs afoul of certain basic standards.

"We are very clearly of the view it is not appropriate to interfere with the methodologies of the rating agencies or to impose on the regulators the task of checking the quality of the ratings, which would be impossible," Holmquist said.

(By R.J. Lehmann, Washington bureau manager: raymond.lehmann@ambest.com)