As the market nears the one-year anniversary of the current credit crunch, many industry participants have gotten past the initial phase of shock and have refocused their attention on learning from past mistakes.

Parts of these discussions center on securities regulation, including the conflict of interest that rating agencies face when assigning fee-based ratings. This was one of the topics of conversation at not only the Securities Industry and Financial Markets Association's Fixed Income Legal & Compliance Conference in New York last Wednesday, but it was also in the news as New York State Attorney General Andrew Cuomo struck a deal with the three major rating agencies to reduce such issues.

The deal between Cuomo and Moody's Investors Service, Standard & Poor's and Fitch Ratings mandated that the rating agencies be paid for their reviews of non-prime RMBS, even if they were not chosen to rate the deal. This would reduce the incentive for agencies to assign high ratings to generate a steady flow of business.

Conference panelists highlighted the problems surrounding the current issuer pay model and the desire for better ratings disclosure.

While not commenting directly on the Cuomo plan, Robert Colby, deputy director of trading and markets at the U.S. Securities and Exchange Commission, suggested that rating agencies could publish the entire rating history for each rated asset so that market participants could see how bonds performed with respect to their ratings.

He also acknowledged that while issuer pay models suffered from conflicts of interest, so did subscriber pay models, which had been suggested in the market before news of the Cuomo plan. Under this proposal, rating agencies would be paid for their ratings by investors and not by the issuers who are arranging the deals.

However, investors also want certain ratings for transactions, and it is hard to avoid conflicts from this end as well, Colby said.

More to Blame

But a conflict of interest did not only reside on the rating agency level; it stretched across the Street. Panelists agreed that current troubles are also the result of improper risk management and government regulation, which was pushed behind rising profits during the housing bubble.

"Regulation takes a back seat in a bull market," said panelist Richard Bernstein, chief investment strategist at Merrill Lynch. "Politicians do not want to stand in the way of a bull market."

Risk managers also face a conflict of interest, a problem that is not new to the market but one that has become an increasingly troublesome issue. "The problem with risk management is that you can't anticipate risk," Bernstein said. He noted that good risk managers are fired in a bull market for suspending new business, and bad ones are fired in a bear market for encouraging new business.

In remaining conservative, market participants suffered from not being competitive, especially when there was no tangible and immediate danger. "It is very hard to lean against the wind for managers, especially when forecasts for bubbles can be very early," said panelist Floyd Norris, chief financial correspondent at the New York Times.

But as panelists were quick to focus on what fueled the fire, they were also keen on addressing conflicts of interest that might arise after the dust has settled.

As the dislocation in the credit markets continues, corporate issuers have become interested in speaking with traders to get more color on the market; for instance, how securities are trading or what they are pricing at, said panelist Juno Mayer Senft, managing director at Merrill Lynch. She cautioned that firms need to talk internally and develop a framework for how these discussions should take place and whether or not confidential information can be shared with traders.

Currently, there are guidelines that are being discussed for hedge funds, but they should also be developed for all buy-side clients, Mayer Senft said.

In the ABS market, some of the SIV restructuring has called for traders to be part of the deal team. This creates the dilemma of what information they can be privy to, panelists agreed, because even if they do not trade that particular security, it becomes a matter of whom they know that does, one of the panelists said.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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