The US Securities and Exchange Commission (SEC) yesterday published a report detailing the results of its investigation on the three main credit rating agencies' practices in rating products that reference residential mortgage-backed securities (RMBS).
The investigation of Moody's, Fitch and Standard & Poor's started in August 2007, as the crisis in subprime residential mortgages in the US became a widespread concern in the markets.
The report identifies significant failings in several areas, but one of its main observations is that the growth in RMBS and collateralised debt obligation (CDO) deals that were submitted for ratings from 2002 onwards meant the agencies struggled to keep pace. While staffing levels increased incrementally with growth in RMBS, the same cannot be said of CDOs, said the SEC.
"With respect to CDOs ... two rating agencies' staffing increases did not appear to match their percentage increases in deal volume," says the report. "The structured finance products that the rating agencies were asked to evaluate also became increasingly complex, including the expanded use of credit default swaps to replicate the performance of mortgage-backed securities."
The report also states that internal documents show two rating agencies issued ratings on some products even though outstanding issues were raised during the analysis of the deals.
The SEC also anonymously quotes an email from an analytical manager in an agency's CDO group referring to an "even bigger monster - the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters. ;o)" in a footnote in the report.
Other emails refer to pressures related to the sheer volume of deals. It also refers to documents that show that "out of model" rating adjustments were often made, meaning rating agencies' full criteria for ratings were not wholly disclosed in many cases. In addition, the report identifies an issue of "less robust" surveillance procedures and documentation compared with initial ratings processes.
"We've uncovered serious shortcomings at these firms, including a lack of disclosure to investors and the public, a lack of policies and procedures to manage the rating process, and insufficient attention to conflicts of interest," said Christopher Cox, chairman of the SEC, in a release issued on July 8.
The regulator had already required the agencies to register in September last year, and has now recommended action be taken on each of the points raised. Among other things, the SEC will monitor staffing and resources, including surveillance, disclosures relating to processes and methodologies, the conflict of interest arising from the fee structure and the internal auditing processes.
Topics: Christopher Cox
More on Risk Management
Harvey Stein combines risk-neutral and real-world measures into risk methodology
ABSTRACT In this paper, we study the evolution over time of the correlation structure of equity returns by means of a filtered-network approach and use this to investigate persistency and recurrences...
Stays will extend to buy-side, repo, and securities lending, says BoE’s Gracie
Welcome to The Journal of Computational Finance's Online First Forum. Here you will find the latest peer reviewed, accepted papers before they are available in print. With Online First publication,...
Sign up for Risk.net email alerts
Sponsored video: MarketAxess
Sponsored video: Tradeweb
Multifonds talks to Custody Risk on being nominated for the Post-Trade Technology Vendor of the Year at the Custody Risk Awards 2014
Sponsored webinar: IBM Risk Analytics
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.