Rating agency reform adopted by the Securities and Exchange Commission to prevent conflicts of interest and improve accountability fail to address a significant issue: issuers shopping around for the most favorable ratings.
The SEC is requiring rating agencies to erect strict boundaries between sales staff and employees handing out ratings to the securities, as part of an effort to prevent firms from luring clients with the prospect of favorable ratings. But that does not prevent issuers from pitting agencies against each other.
“Rating shopping is alive and well; (it’s) most obvious in CMBS,” Calvin Wong, chief credit officer at Morningstar, said at the general session of ABS East conference Tuesday morning.
Wong said that there was some expectation that the SEC would consider creating a board that assigns rating agencies to provide initial ratings on deals, as is required by Senator Franken's Restore Integrity to Credit Rating Amendment.
Wong said that the process of pitching to rate securitizations can be time consuming and doesn’t always pay off for ratings agency. He said that issuers typically invite all of the agencies to perform analysis on a deal, and based on results will pick two or three to rate the deal. The work of the agencies not picked, never sees the light of day. “Availability of the information is actually suppressed by this process because investors don’t have access to this very important information.”
Wong said that Morningstar ends up rating about three of every 10 deals it is asked to participate in.
The upside is that the ongoing ratings shopping has not led to a race to the bottom by the rating agencies; they are sticking to their methodologies. “There has been some concern in CMBS, regarding the weaker underwriting, but credit enhancement is higher too; for the most part rating agencies are holding their ground,” he said.
Wong said that he would like regulators to include the rating shopping process as part of the information that is disclosed to investors, so that even if a rating agency isn’t ultimately chosen to rate the deal, the work that they’ve done would add another level of disclosure to buyside parties.