The credit rating agencies came under fire last week at a Senate committee hearing where critics called for legislation to address potential conflicts of interest and barriers to competition.
Reactions from the asset-backed securities market ranged from mild interest to alarm.
The concern focused mostly on one aspect of the debate: if and how lawmakers should tackle potential conflicts of interest. Several observers are troubled by the possibility of the rating process itself being subject to government oversight as part of the effort to control conflicts of interest. But the sentiment at Tuesday's hearing skewed heavily toward imposing new regulations on the rating agencies.
Of the eight people who testified before the Senate Committee on Banking, Housing and Urban Affairs, only one - a Standard & Poor's executive - argued against more government oversight.
Andrew Gray, a spokesman for the committee, said the Senate has not yet introduced any bills on the issue, though the House of Representatives has. That bill, HR 2990, is in the House Financial Services Committee.
Corporate scandals like Enron prompted the legislative scrutiny of the rating agencies, with critics saying the industry is so concentrated it amounts to a "duopoly." Only five companies are designated as Nationally Recognized Statistical Rating Organizations by the Securities and Exchange Commission. Two of them, Moody's Investors Service and S&P, dominate the industry, taking in 80 percent of the revenues, according to testimony at the hearing.
Critics, including the AFL/CIO, the American Enterprise Institute, and the Investment Company Institute, urged the Senate committee to foster more competition by changing the way NRSRO status is granted. They also called for measures to make the rating agencies more accountable, citing potential conflicts of interest with having issuers pay for ratings and other services.
In contrast with testimony at the hearings, players in the asset-backed securities market generally defended the rating agencies.
Craig Wolson, a partner at the New York law office of Duane Morris, said additional regulation is unnecessary.
"An extra layer of bureaucracy won't serve any good purpose," he said.
Wolson, who most often represents asset-backed issuers, but also works for sponsors and investors, believes the rating agencies are diligent and conservative.
"I've never seen rating agencies cowed into giving a better rating than they felt was deserved," Wolson said. "There are times when they may have been wrong or they may have missed something. But I don't think any government regulations would change that."
At least one analyst called the potential for interference on ratings "dangerous."
Mark Adelson, who heads structured finance research at Nomura Securities, but previously worked at Moody's, believes regulation of rating agencies is akin to regulation of the press.
He acknowledged that legislators are reacting to scandals such as Enron, but said their effort to exert more control over rating agencies violates the First Amendment.
"It may be well-intentioned, but it is dangerous," Adelson said.
George Miller, executive director of the American Securitization Forum, doesn't consider the Senate committee hearing worrisome. He said any potential concerns would depend on what legislation is ultimately proposed.
Miller said market players generally favor increased rating agency competition, which is one goal expressed by the legislators. But the ASF, which has a task force to examine the issue of rating agency oversight, is still working out its views on the best way to foster more competition.
Miller said the debate about how potential conflicts of interest should be managed is a separate matter, which could raise concern. He said ratings should be free of influence by anyone, including the government.
"Any time you have potential influencers that might affect the views ratings agencies express - whether that is undue influence from issuers or, for that matter, from government entities - that is potentially problematic," Miller said. "I think most people in the marketplace would say the government really has no appropriate role in telling rating agencies how substantively to conduct their business, what they should be looking at when assigning ratings or passing judgment on whether any particular rating is or is not warranted."
Tom Deutsch, the ASF's associate director, said the market would like to see a mechanism to measure the performance of rating agencies and assess the accuracy of their ratings over time.
"If there are new entrants in the market, that would be especially important," Deutsch said.
But, Miller added the government should stay out of the business of evaluating ratings.
"The market is really best equipped to evaluate if ratings that are assigned are accurate and reliable," Miller said.
In her testimony before the Senate committee, Vickie Tillman, executive vice president for S&P's Credit Market Services, said her company favors increased competition. But she believes reform of the NRSRO system should come from the SEC, not from legislation.
The SEC approved a proposal to make the NRSRO requirements more transparent last year, but has let the initiative languish since then. Tillman asked the committee to spur the SEC into action.
Tillman also argued that government oversight of the rating agencies would undermine their independence and violate the First Amendment.
"Ratings are opinions, and analysts and rating committees must be free to form those opinions without fear of being second-guessed or subjected to rebuke for ratings that others might feel are either too high or low," Tillman said.
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