Rule 17g-5 could be enhanced to offer structured finance buyers with more transparency on the rating agency selection process, according to a comment letter Fitch Ratings is submitting to the Securities and Exchange Commission. (SEC).
Fitch recommended that Rule 17g-5, which was designed to provided hired and non-hired credit rating agencies access to the same level of data, be enhanced so that these agencies are required to list publicly on their Web sites all structured finance deals that they have been engaged to provide feedback, regardless of whether the agency is ultimately asked to rate the offering.
To avoid disclosing confidential information, publication would occur at the time that the transaction's offering documents become public. In this manner, investors would be able to directly compare which CRAs reviewed the transaction versus those that were ultimately selected to rate it. Such a mechanism would significantly increase the transparency surrounding the credit agency selection process.
The rating agency is now preparing a comment letter in response to the Commission's Solicitation of Comment to Assist in Study on Assigned Credit Ratings, required by Section 939F of the Dodd-Frank Act. The study reviewed the process and practices for the selection of these agencies for structured finance products, evaluate the potential conflicts of interest associated with the issuer-pay and subscriber pay models, and analyze alternative rating agency compensation and selection methods.
The SEC study was meant to address the feasibility of establishing a system where a public or private utility, established by the government, selects which agency determines the credit ratings for structured finance deals. The closing date for responses is Sept. 13.
Fitch will respond by noting that market and regulatory forces together have driven numerous positive changes in managing conflicts of interest and in the level of disclosure available to investors regarding the CRA selection process. For instance, the major CRAs are periodically issuing unsolicited assessments of major structured finance deals and issuers have started to include language in offering documents describing which CRAs they selected and why. These developments are clearly in the spirit of the SEC's CRA related rulemaking.
Fitch said that enhancing Rule 17g-5 represents the most effective way for managing possible conflicts within the credit rating agency selection process, stated Ian Linnell, group managing director and head of global structured finance for the rating agency.
"This approach builds on existing initiatives, minimizes competitive distortions, and is cost effective,"
A notable shortcoming of the SEC's program for 17g-5 is that each CRA's list of 17g-5 related deals is only viewable by other rating agencies. This restriction really limits its usefulness to buysiders. Fitch said that enhancing 17g-5 so that the list is available to investors and the public will help resolve this weakness.
This enhancement, Fitch added, could be implemented with almost no cost as the systems, processes and procedures already added costs would be borne by the rating agencies. AlthoughRule 17g-5 has not yet produced any unsolicited ratings, it has provided CRAs with timely data including an up-to-date inventory of active offerings. This disclosure has helped significantly in the production of unsolicited transaction level commentary.
Fitch's response will also look at the Dodd-Frank Act's requirement that the SEC consider, if it thinks necessary, the establishment of other CRA assignment systems that stop issuers and others from selecting the rating agency. One of the suggested alternatives, which is the proposed 15E(w) System, sometimes referred to as the Franken Amendment, will create a government established board that would select which rating agency rates each structured finance deal.
No agency selection or compensation model is free from potential conflict,Fitch said. Instead, these probable conflicts need to be recognized, fully disclosed and managed carefully. The introduction by regulators of new CRA compensation or selection schemes just posts a new set of conflicts that need to be managed. Fitch has established processes and procedures in place to manage the probable conflicts in its business.
It is not clear at this point, according to Fitch, whether the potential changes implemented by the SEC as a result of the study will be applied globally to structured finance market participants or be limited to only the U.S. market. For a copy of the SEC's request for comment, please click here.