The Senate Banking Committee last Wednesday passed a version of legislation that aims to give the Securities and Exchange Commission explicit authority to regulate credit rating agencies. The Credit Rating Agency Reform Act of 2006, aims to increase competitiveness in the industry, address conflicts of interest, and if necessary, counter abusive practices.
Specifically, the legislation would require companies seeking status as nationally recognized statistical rating organizations (NRSROs) to disclose information, including policies and procedures to prevent the misuse of nonpublic information, their code of ethics, a list of large subscribers and issuers, conflicts of interest and their organizational structure.
Candidates for NRSRO status must meet strict requirements from the SEC, should the Senate version become law. They must have at least a three-year operating record as credit rating agencies and obtain written certification from institutional investors who have used their ratings for at least three years. If any agency lacks adequate financial and managerial resources to consistently produce credit ratings with integrity and comply with application requirements, the legislation empowers the SEC to deny that company registration as an NRSRO.
One of the main goals of the legislation is to promote competition by making it easier for companies to obtain NRSRO status from the SEC. It also comes slightly more than two weeks after the U.S. House of Representatives passed its own version of legislation to reign in the industry, the Credit Rating Agency Duopoly Relief Act of 2006.
"There has been testimony that the SEC staff's designation process has created an artificial barrier to entry which, according to the Department of Justice's antitrust division, is "nearly insurmountable," according to a summary from the Senate Banking Committee. Only five credit rating agencies carry NRSRO status, and two of them, Moody's Investors Service and Standard & Poor's, hold a combined 80% share of the credit ratings market. By not favoring one particular credit rating agency business model, the legislation encourages quantitative firms and subscriber-based models to compete with the qualitative, issuer-paid structures of the current dominant firms, according to the committee.
Fitch Ratings warmly greeted the proposed legislation, saying it would strengthen the competitive environment for the credit rating industry.
"Fitch has always believed that objective indicators of reliability are critical components of rating agency recognition," according to a company statement. "The public interest will not be served if the ratings of agencies without proven records of reliability are indiscriminately used in safety and soundness regulations."
The bill also codifies accountability for the credit rating agencies, by requiring that registered firms promptly update their application information in the event of any material changes and make annual certifications that the existing information is accurate.
"The Senate bill contains some improvements that were incorporated into the House bill to avoid unintended consequences for the industry and market participants who rely on the quality and independence of credit ratings," said Fran Laserson, vice president of corporate communications for Moody's. "We want to preserve the environment where rating agencies can continue to provide objective, direct and independent ratings opinions."
The proposal now moves to the full Senate for consideration.
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