SEC formally proposes credit rating agency conduct rule reforms

Three-part reform of rating agencies’ code of conduct proposed by the SEC

WASHINGTON, DC – US regulator the Securities and Exchange Commission (SEC) has formally proposed a series of reforms intended to increase transparency in the credit ratings process. A new set of conduct rules for credit rating agencies has been proposed, divided into three parts. The first two, proposed on June 11, concern the need for stronger controls on the levels set for capital, liquidity and risk management. The proposal suggest the levels should be set much higher in order to discourage the use of central bank funds, but not so much higher that they cause banks to transfer capital into unregulated markets.

Rating agencies should be prohibited from issuing ratings on structured products unless sufficient information is available on the underlying assets, which must also be disclosed. They are also no longer able to rate a product they have structured.

Anyone who participates in determining a credit rating is prohibited from negotiating the fee the issuer pays for it. Gifts from companies they rate have also been prohibited. The regulators now also require disclosure by the rating agencies of all ratings and subsequent rating actions, of their reliance on the due diligence of others, on how frequently ratings are reviewed, on whether different models are used for ratings surveillance than for initial ratings, whether changes made to models are applied retroactively to existing ratings, and any significant out-of-model adjustments.

The second part of the SEC’s proposal requires agencies to differentiate the ratings they issue on structured products from those they issue on bonds.

A third set of recommendations, due to be issued on June 25, are being designed to ensure the SEC’s objectives of rating agencies providing the necessary independent judgments required by investors.