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CAPITAL MARKETS

Credit: Ratings agencies face shake-up

Do the US capital markets require rating agencies to continue to be regulated? It’s a question raised by legislation recently passed by the US House of Representatives and working its way to the Senate.

The Credit Rating Agency Duopoly Relief Bill being considered in Congress might be the beginning of the end of the 30-year-old de facto regulatory system under which the SEC currently “approves” rating agencies.

As is often the case with badly framed regulation, the SEC had no original intention of becoming the de facto regulator of the rating agencies. Nationally recognized statistical rating organizations (NRSROs) came into being via the backdoor in 1975 when the SEC wanted to formulate rules on net capital requirements for broker-dealers and realized that if it were to allow dealers that held highly rated securities to hold less capital it would need to designate the agencies that were competent to judge the quality of securities that the brokers were investing in. Since then the role of the NRSROs has expanded; the SEC accelerates issuance approval for issuers that are regular users of capital and have a high enough rating with an NRSRO. Also, potential investors increasingly demand that securities are rated by one NRSRO or even two.

“The NRSRO system has grossly distorted market pricing and turned issuers and investors alike into price-takers with virtually no free market choice,” says Glenn Reynolds, CEO of CreditSights, an independent credit research firm.

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