The Dodd-Frank Act’s Potential Effects on the Credit Rating Industry

[ProSense]

The Dodd-Frank Act’s Potential Effects on the Credit Rating Industry

James Vickery

Credit rating agencies have been widely criticized in recent years for the poor performance of their ratings on mortgage-backed securities (MBS) and other structured-finance bonds. In response to the concerns of investors and other market participants, the 2010 Dodd-Frank Act incorporates a range of reforms likely to significantly reshape the rating industry. In this post, we discuss these reforms and their implications for investors, regulators, and the rating agencies themselves.

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Responding to these issues, the 2010 Dodd-Frank Act includes a range of provisions intended to improve rating agency incentives and performance. The myriad new provisions include:

• new authority for the Securities and Exchange Commission (SEC) to suspend or revoke a rating agency’s registration if warranted, or to penalize individual agency employees for misconduct;
  
• public disclosure of the assumptions and data used to arrive at each rating, and submission of an annual report on internal controls by each agency;
  
• rules to strengthen corporate governance and board independence;
  
• the use of “look-backs” when agency employees leave to join firms whose ratings they may have influenced;
  
• the creation of an Office of Credit Ratings within the SEC to administer regulations and conduct annual examinations.

One of the most significant provisions concerns the regulatory use of ratings. U.S. financial regulators have typically used ratings to measure and manage risk-taking by financial firms—for example, as an input to calculating minimum required capital buffers for banks and other financial institutions and to determine which securities may be held by money market mutual funds or used as collateral when banks borrow at the Federal Reserve’s discount window (see Basel Committee on Banking Supervision [2009] for more examples).

Dodd-Frank significantly changes the landscape here. First, it removes references to ratings from the Securities Exchange Act and a number of other statutes. Second, it requires federal agencies like the SEC and Federal Reserve to remove references to ratings from their own regulations when those ratings are used to assess the creditworthiness of a security or money market instrument.

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http://libertystreeteconomics.newyorkfed.org/2012/02/the-dodd-frank-acts-potential-effects-on-the-credit-rating-industry.html

[zipplewrath]

1. You realize this is propaganda right?

This is written by the fed, telling us how great the federal govenment is GOING to do with the new laws and regulations. The fed, the same group that thought the last set of regulations were so great, right before the meltdown.

[ProSense]

2. Well

You realize this is propaganda right?

This is written by the fed, telling us how great the federal govenment is GOING to do with the new laws and regulations. The fed, the same group that thought the last set of regulations were so great, right before the meltdown.

...I knew this dismissal was coming. In fact, I posted about the rule when the law passed.

From Yves Smith at Naked Capitalism, who never has anything nice to say about the bill:

Caught napping, sorry folks…

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Well, I’ll be damned, something got watered up in the final version! Here’s the timeline:

Konczal in May bemoans the absence of the stiff 436(g) language (present in the House Bill), from the Senate Bill.

Ritholtz spots some late tightening fiddling with this part of the Bill in mid-June.

And some time after that, the stiff House language (or something like it, because I still can’t find the final version of the words) gets reinstated: and here we are with the sulking RAs.

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http://www.nakedcapitalism.com/2010/07/caught-napping-sorry-folks.html

Repealed by Wall Street Reform:

SEC. 939G. EFFECT OF RULE 436(G).
Rule 436(g), promulgated by the Securities and Exchange Commission under the Securities Act of 1933, shall have no force or effect.

http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf

Fitch Comments on U.S. Financial Reform Act's Implication for Credit Rating Agencies

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Historically, credit rating agencies have never been treated as experts under the Securities Act, appropriately so since ratings are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. While Fitch continues to believe that it is not an expert under the plain meaning of sections 7 and 11 of the Securities Act, it is Fitch's understanding that, absent clarification by the U.S. Securities and Exchange Commission (SEC), immediately after the Dodd-Frank Bill is signed into law an issuer will need to obtain Fitch's written consent to include a Fitch credit rating in a Securities Act registration statement and any related prospectuses. If Fitch provides its consent for ratings to be included into Securities Act registration statements or prospectuses, Fitch will be potentially exposed to 'expert' liability under section 11 of the Securities Act, liability to which Fitch is not currently exposed. Fitch is not willing to take on such liability without a complete understanding of the ramifications of that liability to Fitch's business and the means by which Fitch may be able to effectively mitigate the risks associated therewith. While Fitch will continue to publish credit ratings and research, given the potential consequences, Fitch cannot consent to including Fitch credit ratings in prospectuses and registration statements at this time.

In addition, the Dodd-Frank Act directs the SEC to remove the exemption for credit rating agencies from the SEC's Fair Disclosure Rule (Regulation FD) within 90 days of the enactment of the Dodd-Frank Act. The exemption for credit rating agencies from Regulation FD permits issuers to provide the credit rating agencies with material non-public information without requiring public disclosure of such information. To the greatest extent possible, Fitch will work with the issuer community to put in place appropriate mechanisms so that Fitch can continue to receive confidential information as part of the rating process.

Issuers should consult their legal counsel with respect to the effect of these issues on the issuer and any planned securities offerings.

http://www.businesswire.com/news/home/20100719006158/en/Fitch-Comments-U.S.-Financial-Reform-Acts-Implication

Here was one of the best DU posts on the rule:

While Y'all Were Kvetching About the Controversy Du Jour...Most Important News of the Year Happened
http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=433x384821

[ProSense]

3. Still,

it would be good to know why you believe it's "propaganda."

I mean, at this point it seems like dismissal auto pilot.

[zipplewrath]

6. Would you prefer press release?

This is not an objective author by any stretch. He is someone with a vested interest making predictions about the future. You're asking the head coach about the outcome of the game before the super bowl starts.

[banned from Kos]

4. BS. That would make the CFPB "propaganda" too. The Fed is subject to revision

just as much as any government agency.

[zipplewrath]

5. Technically it is

The polite term is "advocacy journalism" or something like that. But basically it is someone with a vested interests writing articles about how great they are. Some folks tend to want it to mean "evil intent". But it's not all that different from a press release from Chevy about how great the Volt is.